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Does Inflation “Grease the Wheels of the Labor Market”?

In: Reducing Inflation: Motivation and Strategy

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  • David Card
  • Dean Hyslop

Abstract

If nominal wages are downward rigid, moderate levels of inflation may improve labor market efficiency by facilitating real wage cuts. In this paper we attempt to test the hypothesis that downward real wage changes occur more readily in higher-inflation environments. Using individual wage change data from two sources, we find that about 6-10 percent of workers experience nominally rigid wages in a 10- percent inflation environment. This proportion rises to over 15 percent at a 5 percent inflation rate. We use the assumption of symmetry to generate counterfactual distributions of real wage changes in the absence of rigidities. These counterfactual distributions suggest that a 1 percent increase in the inflation rate reduces the fraction of workers with downward-rigid wages by about 0.8 percent, and allows real wages to fall about 0.06 percent faster. A market- level analysis of the effects of nominal rigidities, based on wage growth and unemployment at the state level, is less conclusive. We find only a weak statistical relationship between the rate of inflation and the pace of relative wage adjustments across local labor markets.

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This chapter was published in:

  • Christina D. Romer & David H. Romer, 1997. "Reducing Inflation: Motivation and Strategy," NBER Books, National Bureau of Economic Research, Inc, number rome97-1, October.
    This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 8882.

    Handle: RePEc:nbr:nberch:8882

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    1. Solon, Gary & Barsky, Robert & Parker, Jonathan A, 1994. "Measuring the Cyclicality of Real Wages: How Important Is Composition Bias?," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 109(1), pages 1-25, February.
    2. Kahn, Shulamit, 1997. "Evidence of Nominal Wage Stickiness from Microdata," American Economic Review, American Economic Association, American Economic Association, vol. 87(5), pages 993-1008, December.
    3. David G. Blanchflower & Andrew J. Oswald, 1989. "The Wage Curve," NBER Working Papers 3181, National Bureau of Economic Research, Inc.
    4. Card, David, 1996. "The Effect of Unions on the Structure of Wages: A Longitudinal Analysis," Econometrica, Econometric Society, Econometric Society, vol. 64(4), pages 957-79, July.
    5. Krueger, Alan B & Summers, Lawrence H, 1988. "Efficiency Wages and the Inter-industry Wage Structure," Econometrica, Econometric Society, Econometric Society, vol. 56(2), pages 259-93, March.
    6. David Card, 1995. "The Wage Curve: A Review," Journal of Economic Literature, American Economic Association, vol. 33(2), pages 285-299, June.
    7. Robert J. Shiller, 1997. "Why Do People Dislike Inflation?," NBER Chapters, in: Reducing Inflation: Motivation and Strategy, pages 13-70 National Bureau of Economic Research, Inc.
    8. David E. Lebow & David J. Stockton & William L. Wascher, 1995. "Inflation, nominal wage rigidity, and the efficiency of labor markets," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 95-45, Board of Governors of the Federal Reserve System (U.S.).
    9. Brown, James N & Light, Audrey, 1992. "Interpreting Panel Data on Job Tenure," Journal of Labor Economics, University of Chicago Press, University of Chicago Press, vol. 10(3), pages 219-57, July.
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