This paper reexamines wage and price dynamics in response to permanent shocks to productivity. We estimate a micro-founded dynamic general equilibrium (DGE) model of the U.S. economy with sticky wages and sticky prices using impulse responses to technology and monetary policy shocks. We utilize a flexible specification for wageand price-setting that allows for the sluggish adjustment of both the levels of these variables—as in standard contracting models—as well as intrinsic inertia in wage and price inflation. On the price front, we find that in our VAR inflation jumps in response to an identified permanent technology shock, implying that, on average, prices adjust quickly and that there is little evidence for any intrinsic inflation inertia like that commonly found in models used for monetary policy evaluation. On the wage front, we find evidence for significant inertia in wages and some intrinsic inertia in nominal wage inflation. Our results provide support for the standard sticky-price specification of the New Keynesian model; however, the evidence on the high degree of wage inertia presents a challenge for standard models of wage setting.

analyzed in Taylor (1999), there is encouraging progress in developing optimizing trend-deviation macro models that provide useful insights into the transmission and design of monetary policy. Several controversial features of a minimalist trend-deviation model, with optimizing households, firms, and bond traders, are examined. Dynamic specifications are suggested to improve the data-based realism, while preserving the simplicity, of the minimalist model. Keywords: New-Keynesian macro models; optimizing IS; Phillips curve; time-varying term premiums.

Bank of Canada working papers are theoretical or empirical works-in-progress on subjects in economics and finance. The views expressed in this paper are those of the authors. No responsibility for them should be attributed to the Bank of Canada. ISSN 1701-9397

One result from a rather large literature on optimal monetary policy is that central bankers can obtain better outcomes on average if they have a good understanding of what determines economic behaviour and, importantly, inflation dynamics. For instance, after a shock, policy responses to bring

Board lunchtime workshop, for helpful comments on this research project and paper. The views expressed here are those of the authors and do not necessarily reflect the views of the Board of Governors of the Federal Reserve System or its staff, the management of the Federal Reserve Bank of San Francisco, or the OECD.

This paper derives and presents mean leads and lags as well as patterns of relative importance weights implied by the PAC (polynomial-adjustment-cost) error-correction equations which form the core of the FRB/US model at the Federal Reserve Board. Relative importance weights measure the contributions of past and future expected changes in fundamentals on current decisions. These and the associated mean lags and leads can be considered summary measures of key dynamic properties of FRB/US. The spending equations are those for total consumption, durable consumption, business equipment, residential housing, and private inventories. The pricing equations are those for the price level and wage growth. In addition FRB/US has one PAC equation for dividends and one for labor hours. JEL Classification: C3,C5,E1