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The effects of inflation on wage adjustments in firm-level data: grease or sand?

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  • Erica L. Groshen
  • Mark E. Schweitzer

Abstract

This paper studies the effects of inflation on wage changes made by firms in a unique thirty-seven-year panel of occupations and employers drawn from the Federal Reserve Bank of Cleveland Community Salary Survey (CSS). Our analysis first identifies two relative prices embedded in wage changes and, second, draws inferences about the costs and benefits of inflation from the adjustments in these relative prices. Typically, firms manage employer-wide wage adjustments (controlling for occupational wage changes) separately from their interoccupational wage changes (controlling for employer wage hikes). Consistent with this observation, we identify large independent employer and occupational components of wage changes in the CSS. Although there is no a priori reason why these adjustments should be altered by inflation (when the average change is subtracted out), we find that variation in both of these terms rises as inflation grows. Guided by institutional wage-setting procedures, we view employers' mean wage hikes as subject to intra-market variations in the speed of adjustment to inflation and forecasting errors. In contrast, we argue that occupational wage movements include a higher concentration of inter-market relative price adjustments. This simple dichotomy, whose robustness we attempt to test, yields two policy-oriented results. First, higher inflation and labor productivity appear to increase the rate of occupational wage adjustments ("grease"), although these potential benefits taper off after inflation rises to about 4 percent (assuming 1.5 percent average growth of labor productivity.) Second, potentially inefficient variations in employer wage adjustments ("sand") continue to mount until inflation reaches rates of 7 to 10 percent (again assuming productivity growth of 1.5 percent).

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Bibliographic Info

Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 9.

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Date of creation: 1996
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Handle: RePEc:fip:fednsr:9

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Related research

Keywords: Inflation (Finance) ; Labor productivity ; Labor market ; Wages;

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References

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  1. Card, David, 1990. "Unexpected Inflation, Real Wages, and Employment Determination in Union Contracts," American Economic Review, American Economic Association, vol. 80(4), pages 669-88, September.
  2. Holzer, Harry J & Montgomery, Edward B, 1993. "Asymmetries and Rigidities in Wage Adjustments by Firms," The Review of Economics and Statistics, MIT Press, vol. 75(3), pages 397-408, August.
  3. Hamermesh, Daniel S, 1986. "Inflation and Labour Market Adjustment," Economica, London School of Economics and Political Science, vol. 53(29), pages 63-73, February.
  4. Levine, David I, 1993. "Fairness, Markets, and Ability to Pay: Evidence from Compensation Executives," American Economic Review, American Economic Association, vol. 83(5), pages 1241-59, December.
  5. Julie L. Hotchkiss, 1990. "Compensation policy and firm performance: An annotated bibliography of machine-readable data files," Industrial and Labor Relations Review, ILR Review, Cornell University, ILR School, vol. 43(3), pages 274-289, February.
  6. Erica L. Groshen & Mark E. Schweitzer, 1997. "Identifying Inflation's Grease and Sand Effects in the Labor Market," NBER Working Papers 6061, National Bureau of Economic Research, Inc.
  7. Hartman, Richard, 1991. "Relative Price Variability and Inflation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(2), pages 185-205, May.
  8. David Card & Dean Hyslop, 1996. "Does Inflation "Grease the Wheels of the Labor Market"?," NBER Working Papers 5538, National Bureau of Economic Research, Inc.
  9. Stanley Fischer, 1981. "Relative Shocks, Relative Price Variability, and Inflation," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 12(2), pages 381-442.
  10. Lach, Saul & Tsiddon, Daniel, 1992. "The Behavior of Prices and Inflation: An Empirical Analysis of Disaggregated Price Data," Journal of Political Economy, University of Chicago Press, vol. 100(2), pages 349-89, April.
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  12. Tobin, James, 1972. "Inflation and Unemployment," American Economic Review, American Economic Association, vol. 62(1), pages 1-18, March.
  13. Laurence Ball & N. Gregory Mankiw, 1995. "A Sticky-Price Manifesto," NBER Working Papers 4677, National Bureau of Economic Research, Inc.
  14. Cukierman, Alex, 1983. "Relative price variability and inflation: A survey and further results," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 19(1), pages 103-157, January.
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  16. Reinsdorf, Marshall, 1994. "New Evidence on the Relation between Inflation and Price Dispersion," American Economic Review, American Economic Association, vol. 84(3), pages 720-31, June.
  17. George J. Stigler & James K. Kindahl, 1970. "The Behavior of Industiral Prices," NBER Books, National Bureau of Economic Research, Inc, number stig70-1.
  18. Allan Drazen & Daniel S. Hamermesh, 1986. "Inflation and Wage Dispersion," NBER Working Papers 1811, National Bureau of Economic Research, Inc.
  19. Katharine G. Abraham & John C. Haltiwanger, 1995. "Real Wages and the Business Cycle," Journal of Economic Literature, American Economic Association, vol. 33(3), pages 1215-1264, September.
  20. George A. Akerlof & William R. Dickens & George L. Perry, 1996. "The Macroeconomics of Low Inflation," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 27(1), pages 1-76.
  21. Haley, James, 1990. " Theoretical Foundations for Sticky Wages," Journal of Economic Surveys, Wiley Blackwell, vol. 4(2), pages 115-55.
  22. Groshen, Erica L, 1991. "Sources of Intra-industry Wage Dispersion: How Much Do Employers Matter?," The Quarterly Journal of Economics, MIT Press, vol. 106(3), pages 869-84, August.
  23. Friedman, Milton, 1977. "Nobel Lecture: Inflation and Unemployment," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 451-72, June.
  24. Sheshinski, Eytan & Weiss, Yoram, 1977. "Inflation and Costs of Price Adjustment," Review of Economic Studies, Wiley Blackwell, vol. 44(2), pages 287-303, June.
  25. 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 95-45, Board of Governors of the Federal Reserve System (U.S.).
  26. Vining, Daniel R, Jr & Elwertowski, Thomas C, 1976. "The Relationship between Relative Prices and the General Price Level," American Economic Review, American Economic Association, vol. 66(4), pages 699-708, September.
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