Economic theory and econometric dynamics in modelling wages and prices in the United Kingdom

We show that a 'competing claims' model of imperfect competition can explain the movements of wages and prices in the United Kingdom, using quarterly data covering 1976-93. We argue that careful attention both to economic theory and to the interaction between dynamics and identification is crucial in the building of the model and to dynamic econometric models in general. We use a small numerical example with simulated cointegrated data to illustrate the potential pitfalls.