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Identifying Inflation's Grease and Sand Effects in the Labor Market

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  • Erica L. Groshen
  • Mark E. Schweitzer

Abstract

Inflation has been accused of causing distortionary price and wage fluctuations (sand) as well as lauded for facilitating adjustments to shocks when wages are rigid downwards (grease). This paper investigates whether these two effects can be distinguished from each other in a labor market by the following identification strategy: inflation-induced deviations among employers' mean wage changes represent unintended intramarket distortions (sand), while inflation-induced, inter-occupational wage changes reflect intended alignments with intermarket forces (grease). Using a unique 40-year panel of wage changes made by large mid-western employers, we find a wide variety of evidence to support the identification strategy. We also find some indications that occupational wages in large firms gained flexibility in the past four years. These results strongly support other findings that grease and sand effects exist, but also suggest that they offset each other in a welfare sense and in unemployment effects. Thus, at levels up to five percent, the net impact of inflation on unemployment is beneficial but statistically indistinguishable from zero. It turns detrimental after that. When positive, net benefits never exceed a tenth of gross benefits.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6061.

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Date of creation: Jun 1997
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Publication status: published as The Costs and Effects of Price Stability. Feldstein, Martin, ed., Chicago: The University of Chicago Press, 1999, pp.273-308.
Handle: RePEc:nbr:nberwo:6061

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  9. Erica L. Groshen & Mark E. Schweitzer, 1996. "The effects of inflation on wage adjustments in firm-level data: grease or sand?," Staff Reports, Federal Reserve Bank of New York 9, Federal Reserve Bank of New York.
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