The objective of this paper is to provide an optimizing model of wage and price
setting consistent with U.S. data. I first investigate the predictions of an optimizing
labor supply model for the aggregate nominal wage, taking as given the evolution of
prices and quantities. In this part I seek to determine whether a standard specification
of households’ preferences over consumption and leisure is consistent with the data,
and to what extent nominal rigidities in the wage setting process improve the fit with
the data. Then I combine the evolution of wages predicted by this model with the
evolution of prices predicted by staggered-price models to provide a model of the joint
determination of prices and wages, given the evolution of real quantities. The paper
thus supplies a “Phillips curve” specification that is consistent with intertemporal
optimization and rational expectations.