Inflation Dynamics with Search Frictions: A Structural Econometric Analysis

FRB Richmond Working Paper No. 08-1

52 Pages Posted: 11 Dec 2012

See all articles by Michael U. Krause

Michael U. Krause

University of Cologne

Thomas Lubik

Federal Reserve Banks - Federal Reserve Bank of Richmond

David Lopez-Salido

Board of Governors of the Federal Reserve System

Multiple version iconThere are 2 versions of this paper

Date Written: March 1, 2008

Abstract

The New Keynesian Phillips curve explains inflation dynamics as being driven by current and expected future real marginal costs. In competitive labor markets, the labor share can serve as a proxy for the latter. In this paper, we study the role of real marginal cost components implied by search frictions in the labor market. We construct a measure of real marginal costs by using newly available labor market data on worker finding rates. Over the business cycle, the measure is highly correlated with the labor share. Estimates of the Phillips curve using GMM reveal that the marginal cost measure remains significant, and that inflation dynamics are mainly driven by the forward-looking component. Bayesian estimation of the full new Keynesian model with search frictions helps us disentangle which shocks are driving the economy to generate the observed unit labor cost dynamics. We find that mark-up shocks are the dominant force in labor market fluctuations.

Keywords: Phillips curve, Bayesian estimation, marginal costs, labor market frictions

JEL Classification: E24, E32, J64

Suggested Citation

Krause, Michael U. and Lubik, Thomas and Lopez-Salido, David, Inflation Dynamics with Search Frictions: A Structural Econometric Analysis (March 1, 2008). FRB Richmond Working Paper No. 08-1. Available at SSRN: https://ssrn.com/abstract=2187912 or http://dx.doi.org/10.2139/ssrn.2187912

Michael U. Krause

University of Cologne ( email )

Albertus-Magnus-Platz
Cologne, 50923
Germany

Thomas Lubik (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Richmond ( email )

P.O. Box 27622
Richmond, VA 23261
United States

David Lopez-Salido

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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