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Evaluating the economic significance of downward nominal wage rigidity

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  • 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 the presence of worker resistance to nominal wage cuts - something that has previously been considered intractable. In particular, we show that this resistance renders wage increases (partially) irreversible. Second, using this model, we can explain why previous estimates of the macroeconomic effects of DNWR have been so weak despite remarkably robust microeconomic evidence. In particular, we show that previous studies have neglected the possibility 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-data for the US and Great Britain, we find robust evidence in support of the predictions of the model. In the light of this evidence, we conclude that increased wage pressure due to DNWR may not be as large as previously envisaged, but that the data is nevertheless consistent with a model in which workers resist nominal wage cuts.

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File URL: http://eprints.lse.ac.uk/19882/
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Bibliographic Info

Paper provided by London School of Economics and Political Science, LSE Library in its series LSE Research Online Documents on Economics with number 19882.

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Length: 59 pages
Date of creation: Aug 2005
Date of revision:
Handle: RePEc:ehl:lserod:19882

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Keywords: Nominal Wage Rigidity; Loss Aversion; Irreversibility;

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