An Optimizing Model of U.S. Wage and Price Dynamics

Abstract

The objective of this paper is to provide an optimizing model of wage and price setting consistent with U.S. data. I first investigate the predictions of an optimizing labor supply model for the aggregate nominal wage, taking as given the evolution of prices and quantities. In this part I seek to determine whether a standard specification of consumption/leisure preferences is consistent with the data, and to what extent nominal or real rigidities in the wage setting process improve the fit withthedata. Then I combine the evolution of wages predicted by this model with the evolution of prices predicted by staggered-price models to provide a model of the joint determination of prices and wages, given the evolution of real quantities. The paper thus supplies a “Phillips curve ” specification that is consistent with intertemporal optimization and rational expectations.

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