"Wage and Price Phillips Curves. An empirical analysis of destabilizing wage-price spirals"

Peter Flaschel
University of Bielefeld, Germany

Hans-Martin Krolzig
Department of Economics, Oxford University, England
	
Abstract: In this paper we introduce a small Keynesian model of economic growth which 
is centered around two advanced types of Phillips curves, one for money wages and one 
for prices, both being augmented by perfect myopic foresight and supplemented by a 
measure of the medium-term inflationary climate updated in an adaptive fashion. 
The model contains two potentially destabilizing feedback chains, the so-called
Mundell and Rose-effects. We estimate parsimonious and congruent Phillips curves
for money wages and prices in the US over the past five decades.  Using the parameters 
of the empirical Phillips curves, we show that the growth path of the private sector 
of the model economy is likely to be surrounded by centrifugal forces. Convergence to 
this growth path can be generated in two ways: a Blanchard-Katz-type error-correction 
mechanism in the money-wage Phillips curve or a modified Taylor rule that is augmented 
by a term, which transmits increases in the wage share (real unit labor costs) to increases
in the nominal rate of interest. Thus the model is characterized by local instability of the
wage-price spiral, which however can be tamed by appropriate wage or monetary policies.
Our empirical analysis finds the error-correction mechanism being ineffective
in both Phillips curves suggesting that the stability of the post-war US macroeconomy
originates from the stabilizing role of monetary policy.

Jel Classification: E24, E31, E32, J30

Keywords: Phillips curves; Mundell effect; Rose effect; Monetary policy; Taylor Rule; Inflation; 
Unemployment; Instability