Wage and Price Dynamics: A Limited-Information Approach

This paper analyzes the dynamics of prices and wages using a limited-information approach to estimation. I estimate a two-equation model for the determination of prices and wages derived from an optimization-based dynamic model, where both goods and labor markets are monopolistically competi-tive, prices and wages can be reoptimized only at random inter-vals, and, when not reoptimized, can be partially adjusted to previous-period aggregate inflation. The estimation procedure is a two-step minimum-distance estimation, which exploits the restrictions that the model imposes on a time-series represen-tation of the data. In the first step I estimate an unrestricted autoregressive representation of the variables of interest. In the second step, I express the model solution in the form of a con-strained autoregressive representation of the data and define the distance between unconstrained and constrained represen-tations as a function of the structural parameters that char-acterize the joint dynamics of inflation and labor share. This function summarizes the cross-equation restrictions between the model and the time-series representations of the data: I then estimate the parameters of interest by minimizing a quadratic function of that distance. I find that the estimated dynamics of prices and wages track actual dynamics quite well, and that the estimated parameters are consistent with the observed length of nominal contracts