Finance and Economics Discussion Series (FEDS)
April 2023
The Role of Wages in Trend Inflation: Back to the 1980s?
Abstract:
This paper examines whether the measurement of trend inflation can be improved by using wage data in a dynamic factor model of disaggregated prices and wages for the United States. The model features time-varying coefficients and stochastic volatility. An estimate of trend inflation is a time-varying distributed lag of prices and wages, where the weight on a series depends on its time-varying volatility, persistence, and comovement with other series. The results show that wages inform estimates of trend inflation. The weight on wages was highest around 1980, drifted down through the 2000s, and returned to its 1980s value by 2022. In addition, inflation in the 2020s appears to have unmoored moderately from the 2 percent range that prevailed for decades, as the role of the persistent component of inflation increased in recent year. However, accounting for wages lowers the model's view of the increase in the volatility of trend inflation.
Keywords: Factor Model, Price Inflation, Unobserved Components Model, Wage Inflation
DOI: https://doi.org/10.17016/FEDS.2023.022
PDF: Full Paper
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