Wage Growth and the Inflation Process: An Empirical Approach

Abstract

A popular theoretical model of the inflation process is the expectations augmented Phillips curve model. In this model, it is generally assumed that prices are set as a markup over productivity-adjusted labour costs, the latter being determined by the expected inflation rate and the degree of demand pressure.¹ It is assumed further that expected inflation depends on past inflation. This model thus implies that wages and prices are causally related with feedbacks in both directions. However, Gordon (1988) has raised some doubts on the validity of this implication. He found that changes in wages and prices are not related in the Granger-causal sense. His finding also contradicts the results in some early empirical works of Barth and Bennett (1975) in which it was shown that wages and prices are related with Granger-causality running either in both directions or only from prices to wages.

This paper is an expanded and revised version of Mehra (1991).