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Evaluating the Economic Significance of Downward Nominal Wage Rigidity

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Author Info
Michael W. L. Elsby
Abstract

This paper seeks to contribute to the literature on downward nominal wage rigidity (DNWR)along two dimensions. First, we formulate and solve an explicit model of wage-setting in thepresence of worker resistance to nominal wage cuts - something that has previously beenconsidered intractable. In particular, we show that this resistance renders wage increases(partially) irreversible. Second, using this model, we can explain why previous estimates ofthe macroeconomic effects of DNWR have been so weak despite remarkably robustmicroeconomic evidence. In particular, we show that previous studies have neglected thepossibility that DNWR can lead to a compression of wage increases as well as decreases.Thus, the literature may have been overstating the costs of DNWR to firms. Using micro-datafor the US and Great Britain, we find robust evidence in support of the predictions of themodel. In the light of this evidence, we conclude that increased wage pressure due to DNWRmay not be as large as previously envisaged, but that the data is nevertheless consistent with amodel in which workers resist nominal wage cuts.

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Paper provided by Centre for Economic Performance, LSE in its series CEP Discussion Papers with number dp0704.

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Date of creation: Aug 2005
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Related research
Keywords: Nominal Wage Rigidity; Loss Aversion; Irreversibility;

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Find related papers by JEL classification:
J30 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - General
J41 - Labor and Demographic Economics - - Particular Labor Markets - - - Labor Contracts
E24 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution
E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation

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(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Lorenz Goette & David Huffman, 2005. "Do Emotions Improve Labor Market Outcomes?," IZA Discussion Papers 1895, Institute for the Study of Labor (IZA). [Downloadable!]
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