Scandinavian Working Papers in Economics

Memorandum,
Oslo University, Department of Economics

No 25/2002: Coordination, Fair Treatment and Inflation Persistence

Steinar Holden () and John C. Driscoll ()
Additional contact information
Steinar Holden: Dept. of Economics, University of Oslo, Postal: Department of Economics, University of Oslo, P.O Box 1095 Blindern, N-0317 Oslo, Norway
John C. Driscoll: Federal Reserve Board, Postal: Mail Stop 75, 20th and Constitution Avenue, NW, Washington DC 20551

Abstract: Most wage-contracting models with rational expectations fail to replicate the persistence in inflation observed in the data. We argue that coordination problems and multiple equilibria are the keys to explaining inflation persistence. We develop a wage-contracting model in which workers are concerned about being treated fairly. This model generates a continuum of equilibria (consistent with a range for the rate of unemployment), where workers want to match the wage set by other workers. If workers’ expectations are based on the past behavior of wage growth, these beliefs will be self-fulfilling and thus rational. Based on quarterly U.S. data over the period 1955-2000, we find evidence that inflation is more persistent between unemployment rates of 4.7 and 6.5 percent, than outside these bounds as predicted by our model.

Keywords: Inflation persistence; coordination problems; adaptive expectations

JEL-codes: E31

76 pages, June 18, 2003

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