Kiel Working Papers, Kiel Institute for World Economics
No 1342:
Testing Price Equations
Ray C. Fair
Abstract: How inflation and unemployment are related in both the
short run and long run is perhaps the key question in macroeconomics. This
paper tests various price equations using quarterly U.S. data from 1952 to
the present. Issues treated are the following. 1) Estimating price and wage
equations in which wages affect prices and vice versa versus estimating
"reduced form" price equations with no wage explanatory variables. 2)
Estimating price equations in (log) level terms, rst difference (i.e.,
inflation) terms, and second difference (i.e., change in inflation) terms.
3) The treatment of expectations. 4) The choice and functional form of the
demand variable. 5) The choice of the cost-shock variable. The results
reject the use of rational expectations and suggest that the best speci
cation is a price equation in level terms imbedded in a price-wage model,
where the wage equation is also in level terms. The best cost-shock
variable is the import price deflator, and the best demand variable is the
unemployment rate. There is some evidence of a nonlinear effect of the
unemployment rate on the price level at low values of the unemployment
rate. Many of the results in this paper are contrary to common views in the
literature, but the empirical support for them is strong.
29 pages, June 2007
Before downloading any of the electronic versions below
you should read our statement on
copyright.
Download GhostScript
for viewing Postscript files and the
Acrobat Reader for viewing and printing pdf files.
Downloadable files:
kap1342.pdf 
Download Statistics
Report other problems with accessing this service to Sune Karlsson ()
or Helena Lundin ().
Programing by
Design Joakim Ekebom
