Adjusting Wages for Price Inflation: The Rational-Arrangements Phillips Curve

Abstract

A model of nominal labor-price dynamics is derived from the choice of an efficient strategy to adjust wages for inflation. The model, named the rational-arrangements Phillips curve, identifies a central role for catch-up to price inflation that has already occurred and a more latent role for rational expectations of future inflation. The reinterpreted Phillips relationship demonstrates a number of desirable properties. It provides a cogent synthesis of money neutrality and non-neutrality, is consistent with inflation persistence in the aftermath of monetary shocks, informs monetary policymaking in hyper-inflationary periods, limits the practical application of the Lucas critique of macroeconometric model-building, and is congruent with practitioner descriptions of wage-setting arrangements.