Fairness and Inflation Persistence

We argue that peoples' concern for fairness may explain an unsolved puzzle in macroeconomics: the persistence of inflation. We extend a 1990 wage-contracting model of Bhaskar in which workers' disutility from being paid less than other workers exceeds their utility from being paid more. This model generates a continuum of equilibria over a range of wages and unemployment rates. If workers' expectations are based on the past behavior of wage growth, these beliefs will be self-fulfilling, generating inflation persistence within, but not outside of, this range. Based on quarterly U.S. data over the period 1955-2000, we find evidence that inflation is more persistent between unemployment rates of 4.7 and 6.5% than outside these bounds. (JEL: E31, E3, E5) Copyright (c) 2004 The European Economic Association.