Anchored Inflation with Differential Inflation Benchmarks

Abstract

This paper presents a model of inflation and distribution that features a structural difference between the wage Phillips curve and the price Phillips curve. The wage Phillips curve revolves around conditions in the labor market represented by the employment rate while the price Phillips curve revolves around conditions in the product market represented by capacity utilization. Differences in the relative bargaining power of workers and capitalist firms give rise to stabilizing real wage dynamics that lead to normal capacity utilization. Wage and price setting are each benchmarked to a different reference rate of price inflation, and both are anchored by the central bank’s inflation target. Price-setting by capitalist firms requires accurate projections (inflation expectations) of their competitors’ prices while the wage-setting reference rate reflects the delay in keeping up with past inflation that firms impose on workers, so that more anchoring represents the loss of working class bargaining power. Greater anchoring of the wage-setting reference rate relative to the price-setting rate makes real wages vulnerable to erosion from inflation. Capacity constraints also generate inflation that erodes wages. The model sheds some light on the recent post-Covid inflation through these channels.