Will The Rising Labor Income Share Drive Up The Inflation?

Recently the Chinese Communist Party and the government start a new round of reform of income distribution system, in which rising the labor income share is an important component. Rising labor income share needs specifical methods, such as promoting the wage increasing of mid-low employees, adapting the lowest wage standard to the price change in time, promoting the collective consultation on wages, etc. Would these methods increase the cost of firms thus lead to inflation? The purpose of this paper is to examine whether rising labor income share leads to inflation pressure. If the rising labor income does leads to inflation, then the issue of keeping price stable during the process of fast income increasing has to be considered in the policy.Gali and Gertler (1999) introduce labor share into the New Keynesian Phillips curve (NKPC) as the proxy of real marginal cost, in which labor share acts as the forcing variable in the dynamics of inflation, according to which the labor share and the inflation are related, which serves as the theoretical basis of this paper. The examination of NKPC indicates that the rising labor share has the effect of increasing the inflation. The correlation analysis of the series processed by Empirical Mode Decomposition (EMD) shows that the relationship is more significant in the mid-long term. This paper extends the research field of the labor share, on the other hand, it enrich the empirical evidence of NKPC in China.The paper derives the labor share version NKPC as the theoretical basis, estimates it by the GMM, decomposes the inflation and forcing variable by EMD, and discusses the policy implication of the empirical results. The paper is organized as follows:The first chapter introduces the research background and the meaning of the paper, summarizes the current research on the labor share and the inflation, introduces the organization of the paper, and points out the innovations. The second chapter reviews the literatures on labor share and NKPC. The current research on labor share focuses on the measurement, influencing factors, and the relationship with the macroeconomic fluctuation. The influencing factors include industry structure, technical change, labor market system, globalization and other factors. The review of NKPC concentrates on the history, empirical research method and the labor share version NKPC.The third chapter derives the theoretical model of labor share and inflation. According to Gali and Gertler (1999), it uses the Calvo (1983) style, stagger-pricing assumption, to derive the common NKPC, and specifies the production fuction as Cobb-Douglas, derives the labor share version NKPC. At last, it derives the output gap version NKPC basing on the linear relationship between the labor share and output gap. These models are the theoretical basis of the paper.The fourth chapter introduces the econometrical model, variable selection and the source of data. The chapter rewrites the NKPC as suit for the econometric test, gives the hybrid NKPC without derivation. Then the chapter introduces the measure of the inflation, labor share and output gap.Chapter five tests the pure forward looking and hybrid NKPC. Lacking seasonal data of labor share, the paper estimates two versions of labor share. The GMM estimation shows that the labor share has robust, significant, positive influence on inflation, the coefficient of output gap is not robust, and labor share is the more suitable forcing variable of NKPC. The estimation of hybrid NKPC shows that the expect inflation significantly influence the inflation, while the lagged inflation shows non-robust effect. Basing on the same data set, it uses the EMD to decompose the variables, and conducts correlation analysis. The result shows that the relationship between the inflation and the labor share is more significant in the mid-long term, the policy-maker should be aware of the pressure of rising labor share on mid-long term inflation. The sixth chapter discusses the empirical results. By comparing to other literature, the results are similar to them. The empirical results show that the rising labor share influences the inflation, which is the labor cost effect, indicating that the cost pushing inflation exists in China. The influence of income distribution reform on economic fluctuation is usually neglected and the reform in future should be aware of it. In addition, the importance of expectation indicates that the expectation management should be emphasized by the monetary authority.The chapter seven concludes the paper and describes the deficiency.There are three innovations in the paper:firstly, it estimates two versions of seasonal labor share, enabling the robust examining of labor share’s effect on inflation. Secondly, it uses the EMD to classify the fluctuation by period, facilitating the research of the relationship of labor share and inflation on different periods. Thirdly, it builds the relationship of income distribution and the inflation, offering reference for the income distribution reform and the monetary policy. The deficiency of the paper is the estimation of labor share has a significant gap to the annual labor share basing on income-method GDP. The combination of decomposed series by EMD is subjective and lacks of clear meaning of the period length.