Discussion Paper Series 2006-E-25

Can the New Keynesian Phillips Curve Explain Japanese Inflation Dynamics? A Labor Share Correction Approach

Ichiro Muto

We estimate a New Keynesian Phillips curve (NKPC) for Japan's economy. To obtain a better proxy of real marginal cost (RMC), we correct labor share by incorporating labor adjustment costs, material prices, and real wage rigidity. Our approach is unique in utilizing the information on firms' judgment about the labor gap, which implies the existence of labor adjustment costs. Our results show that the NKPC explains Japanese inflation dynamics quite well if we use the corrected proxy of RMC. Furthermore, we find that Japanese inflation persistence is mostly accounted for by the persistence of RMC itself rather than lagged inflation.

Keywords: New Keynesian Phillips Curve; Real Marginal Cost; Labor Adjustment Cost; Material Price; Real Wage Rigidity; Inflation Persistence

Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.

Copyright © 2006 Bank of Japan All Rights Reserved.

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