The International Element in the Phillips Curve

Abstract

A set of internal two-equation price-wage models is formulated for 17 countries. It is then demonstrated that the interconnection is much stronger than can be explained by: (i) imported inflation through import prices including exchange rate changes; (ii) the common element in total demand generated by exports; and (iii) the necessity for competitiveness as formulated in the EFO model. The unweighted average of wage increases in the countries considered is called the ż-variable and is used as a proxy for the unexplained international element. It is demonstrated that the coefficient of ż is remarkably stable over time, across countries and for different estimation techniques. It also appears to be largely unrelated to the trade shares of the countries. Only half of the ż-element is due to common long-term trends. It is often argued that the wage-push elements, i.e. those uncorrelated with labor scarcity, are generated by expectations. We thus conclude that there is a large inter-national element in expectations.

This article is a short version of a working paper (available on request from the author). I am grateful for useful comments and a number of discussions with Jørgen H. Gelting, Svend Hylleberg, Arne O. Krueger, Karsten Laursen and Peder J. Pedersen, as well as for a hint from F. Gerard Adams, and comments from two anonymous referees. Leif Pedersen assisted with the data processing, using the ISIS-system. The article is part of a project which has received several grants from the Danish Social Science Research Council.