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Inflation Dynamics and Labor Adjustments in Japan: A Bayesian DSGE Approach

September 2008
Hibiki Ichiue*1
Takushi Kurozumi*2
Takeki Sunakawa*3

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Abstract

Many studies of inflation dynamics assume that in the presence of competitive labor markets firms adjust labor input only at the intensive margin. We consider labor market search and examine the role of the extensive margin for inflation dynamics by estimating three models with distinct labor adjustments. Our Bayesian estimation result shows that the model with only the extensive margin is superior to that with only the intensive one in terms of marginal likelihood. This suggests that the extensive margin may be more important for inflation dynamics in Japan. We also show that introducing the intensive margin into the extensive margin model further improves marginal likelihood. Moreover, we find that real marginal costs in these models with the extensive margin are highly correlated with the Bank of Japan's estimates of the output gap.

JEL classification:
E24; E32; E37

Keywords:
Inflation dynamics; Marginal cost; Labor market search; Extensive margin; Bayesian estimation

The authors are grateful for discussions and comments from R. Anton Braun, Julen Esteban-Pretel, Ippei Fujiwara, Shin-ichi Fukuda, Ichiro Fukunaga, Fumio Hayashi, Yasuo Hirose, Maiko Koga, Thomas Lubik, Eiji Maeda, Kazuo Momma, Ichiro Muto, Masashi Saito, Etsuro Shioji, Tomohiro Sugo, Nao Sudo, Yuki Teranishi, Kozo Ueda, and Toshiaki Watanabe, as well as seminar participants at the University of Tokyo and the Bank of Japan. Any remaining errors are the sole responsibility of the authors. The views expressed herein are those of the authors and should not be interpreted as those of the Bank of Japan.

  • *1 Research and Statistics Department, Bank of Japan
    E-mail:hibiki.ichiue@boj.or.jp
  • *2 Monetary Affairs Department, Bank of Japan
    E-mail:takushi.kurozumi@boj.or.jp
  • *3 Bank of Japan and Ohio State University

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