An Empirical Study on Wage and Price Stickines in the US Economy (1990-2009)

The study aims to analyze US economy for the years 1990-2009 with emphasis on price adjustment dynamics and provide evidence on the business cycle mechanism. According to New Keynesian thinking major structural trait of the economy is non-clearing markets under imperfect competition with asymmetry and uncertainties. There are two major lines under the NK economics to explain how markets are non-clearing: this may either be due to price rigidity in product or wage rigidity in labor markets. Generally empirical evidence is quite scarce in NK literature whereas theoretical research is abundant. However bulk of recent empirical research in the field has revealed evidence in favor of wage rigidity as opposed to widespread belief for price rigidity in the 1990’s, since the seminal work by Chari, Kehoe, McGrattan in 2000. We estimate six price equations for prices, nominal wages and real wages with the explanatory variables of lagged prices, real GNP growth over trend, nominal GNP growth over trend and level of detrended output. The equations are estimated by OLS and coefficients are interpreted for price or wage rigidity for the term 1990-2009. Estimation of six price equations on price formation has not revealed evidence for price rigidity. On the contrary wage rigidity has been detected in the US economy for the period covering 1990’s and 2000’s pointing at the relevance of the argument that it is actually labor markets where the rigidities stem from, causing non-clearing markets. Wage rigidity has emerged in the form of inertia. This may either be due to expectations or presence of staggered labor wage contracts. Thus we conclude that business cycle dynamics of fluctuations in output and employment should be followed in the labor markets and relevant macro models of the economy should concentrate on them to explain the dynamics.