872 Macroeconometric Modeling for Policy
This is one equation in two endogenous variables,uwand the wedge(p−pi),soit
appears that there is a continuum ofuwvalues depending on the size of the wedge,
in particular of the value of the real exchange rate. It is, however, customary to
assume that the equilibrium value of the wedge is determined by the requirement
that the current account is in balance in the long run. Having thus pinned down
the long-run wedge as a constant equilibrium real exchange rate(p−pi), it follows
that NAIRUuwis determined by (17.33). If the effect of the wedge on wage claims
is not really a long-run phenomenon, thenδ 12 =1 anduwis uniquely determined
from (17.33), and there is no need for the extra condition about balanced trade in
the long run (see Layard, Nickell and Jackman, 2005, p. 33).
Compare this to the asymptotically stable equilibrium consisting ofut =
uss,pt=πandwt+T 1 −qt−zt=wsss. Clearly, inflation is stable, even though
ussis determined “from the outside” and is not determined by the wage- and price-
setting equations of the model. Hence the (emphasized) second sentence in the
above quotation has been disproved: it is not necessary thatusscorresponds to the
NAIRUuwin equation (17.33) for inflation to be stable with a well-defined value
in steady state.
Figure 17.1 illustrates the different equilibria. Wage-setting and price-setting
curves correspond to (deterministic versions) of equations (17.22) and (17.23). The
NAIRUuwis given by the intersection of the curves, but the steady-state rate of
unemploymentussmay be lower thanuw, the case shown in the graph, or higher.
The figure further indicates (by a•) that the steady-state wage share will reside at
a point on the line segment A–B: heuristically, this is a point where price-setters
Wage sharePrice-settingABuss uw uWage-settingFigure 17.1 Real wage and unemployment determination, NAIRU and the steady-state rate
of unemploymentuss