Discussion Paper Series 2018-E-8

Missing Wage Inflation? Estimating the Natural Rate of Unemployment in a Nonlinear DSGE Model

Yuto Iwasaki, Ichiro Muto, Mototsugu Shintani

During the recovery from the global financial crisis, most advanced economies have experienced a surprisingly weak response of wage inflation to the decline in unemployment. In this study, we investigate whether downward wage rigidity (DWR) is the source of the flattening wage Phillips curve and the lack of wage inflation in the four advanced economies: Japan, the euro area, the UK, and the US. Specifically, we apply Markov chain Monte Carlo methods with a particle filter to estimate a nonlinear New Keynesian dynamic stochastic general equilibrium model incorporating asymmetric wage adjustment costs. This enables us to jointly estimate the degree of DWR as well as the natural rate of unemployment, that is, the rate of unemployment expected in the absence of (downward) wage rigidity. Our results indicate that wage adjustment costs are highly asymmetric in Japan, the euro area, and the UK, but not in the US. Especially, an L-shaped wage Phillips curve between wage inflation and the unemployment gap clearly emerges in Japan, due to the presence of DWR. As for the US, wage adjustment costs are large but symmetric, which means that wages are inherently quite sticky both in an upward and downward direction. Our results suggest that missing wage inflation in Japan, the euro area, and the UK is attributable largely to DWR, but not in the US.

Keywords: downward wage rigidity; natural rate of unemployment; Phillips curve; particle filter

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.

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