REAL UNIT LABOR COSTS AND OUTPUT IN BUSINESS CYCLE MODELS: AN EMPIRICAL ASSESSMENT

Modern macroeconomic models of business cycle, which are based on real business cycle models enhanced by various types of both nominal and real rigidities, work with a relation between price inflation and real marginal costs, which captures the sources of inflation introduced much earlier as the Phillips curve. Although it is possible to formulate the relationship with output gap or unemployment gap instead of real marginal costs, it is the formulation with real marginal costs which dominates both in theoretical and empirical analysis. The paper uses VAR models with measures of real activity, inflation, exchange rate and interest rate as endogenous and measures of output of the German economy and oil price as exogenous variables to examine the behavior of real unit labor costs as a proxy for real marginal costs in a business cycle framework in cases of the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland and Slovakia. The results differ significantly across the sample, which means a differentiated approach must be taken when estimating such a relationship.