INFLATION DYNAMICS AND LABOR MARKET SPECIFICATIONS: A BAYESIAN DYNAMIC STOCHASTIC GENERAL EQUILIBRIUM APPROACH FOR JAPAN'S ECONOMY

Authors

  • HIBIKI ICHIUE,

    1. Ichiue: Bank of Japan, 2-1-1 Nihonbashi Hongokucho, Chuo-ku, Tokyo 103-8660, Japan. Phone +81 3 3279 1111, Fax +81 3 5201 6525, E-mail hibiki.ichiue@boj.or.jp
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  • TAKUSHI KUROZUMI,

    1. Kurozumi: Bank of Japan, 2-1-1 Nihonbashi Hongokucho, Chuo-ku, Tokyo 103-8660, Japan. Phone +81 3 3279 1111, Fax +81 3 5255 6758, E-mail takushi.kurozumi@boj.or.jp
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  • TAKEKI SUNAKAWA

    1. Sunakawa: Bank of Japan and The Ohio State University, 410 Arps Hall, 1945 N. High St., Columbus, OH 43210. Phone 614 292 6701, Fax 614 292 3906, E-mail takeki.sunakawa@gmail.com
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    • The authors are grateful for comments and discussions to R. Anton Braun, William Dupor, Julen Esteban-Pretel, Paul Evans, Shin-ichi Fukuda, Fumio Hayashi, Yasuo Hirose, Thomas Lubik, Masao Ogaki, Erwan Quintin (editor), Etsuro Shioji, Willem Van Zandweghe, Toshiaki Watanabe, colleagues at the Bank of Japan, and two anonymous referees, as well as seminar participants at the University of Tokyo, the 2009 Midwest Macroeconomics Meetings, and the 2010 Congress of the European Economic Association. Any remaining errors are the sole responsibility of the authors. The views expressed herein are those of the authors and should not be interpreted as those of the Bank of Japan.


Abstract

Which labor market specification is better able to describe inflation dynamics, a widely used sticky wage model or a recently investigated labor market search model? Using a Bayesian likelihood approach, we estimate these two models with Japan's data. This article shows that the labor market search model is superior to the sticky wage model in terms of both marginal likelihood and out-of-sample forecast performance, particularly regarding inflation. The labor market search model is better able to replicate the cross-correlation among inflation, real wages, and output in the data. Moreover, in this model, real marginal cost is determined by both hiring cost and unit labor cost that varies with employment fluctuations, which gives rise to a high contemporaneous correlation between inflation and real marginal cost as represented in the New Keynesian Phillips curve. (JEL E24, E32, E37)

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