Testing the Dynamics of Wages and Prices for the US economy

This paper demonstrates, contrary to what has been shown recently, that demand pressure, be-sides differentiated cost-pressure, matters both in the labor market and the market for goods in the determination of wage and price inflation. We consider from the theoretical perspective and estimate for the USA, using OLS and more advanced methods, both separately and simultaneously wage and price Phillips curves based on demand pressure measures in the market for labor and for goods, respectively, using weighted averages of short- and medium-run cost-pressure terms in addition. The suggested finding is that on the whole wages are more flexible than prices with respect to their respec-tive demand pressure terms and that price inflation determination gives (somewhat) more weight to medium term inflation than does wage inflation. This implies as reduced form equation a real wage dynamic that depends positively on economic activity, and thus an adverse real wage adjustment, for example if aggregate demand depends positively on temporary real wage changes (which is likely to be the case, at least in states of high economic activity). Monetary policy thus is not only facing adverse real rate of interest adjustments (destabilizing Mundell-effects), but also destabilizing real wage adjustments (adverse real wage effects), and has to take into account in addition an important nonlinearity in money wage formation, their downward rigidity, the subject of section 5 of this paper