Imperfect Information and Wage Inertia in the Business Cycle: A Comment

Mark W. Watson
1983 Journal of Political Economy  
In a recent article, Gertler (1982) presents a model that explains certain stylized facts concerning the relative behavior of the money supply and nominal wages. One additional feature of the model is the behavior of real output, which is found to have a serially correlated response to a money supply shock. This serial correlation appears to arise from an information structure that precludes agents from directly disentangling permanent versus transitory movements in relevant state variables.
more » ... state variables. This information structure complicates the forecasting problem that must be solved to analyze the model and affects the behavior of wages and the variance of output. It will not, however, lead to serial correlation in real output. An algebraic error is responsible for the serial correlation found by Gertler. This note corrects the error and presents an alternative solution to the forecasting problem. Gertler constructs forecasts of the relevant state variable through the use of a Kalman filter. While this technique is appropriate for the problem, a simpler solution is available. This solution is based on an equivalent representation of the stochastic process generating the disturbances of the model. This equivalent representation can then be used, in a straightforward way, to describe wage dynamics and the variance of real output. It is sufficient to analyze Gertler's model in the case where there are only monetary disturbances. The relevant equations are
doi:10.1086/261187 fatcat:7ta45mu6lfdqzabwb6m5ss5z44