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Performance pay and shifts in macroeconomic correlations

  • Francesco Nucci

    ()

    (La Sapienza University of Rome)

  • Marianna Riggi

    ()

    (Bank of Italy)

A coincidence in time between the volatility break associated with the "Great Moderation" and large changes in the pattern of conditional and unconditional correlations between output, hours and labor productivity was detected by Gal� and Gambetti (2009). We provide a novel explanation for these findings, based on the major changes that occurred in the U.S. design of labor compensation around the mid-1980s. These include a substantial increase in the incidence of performance pay coupled with a higher responsiveness of real wages to the business cycle. We capture this shift in the structure of labor compensation in a Dynamic New Keynesian (DNK) model and show that, by itself, it generates the disappearance of the procyclical response of labor productivity to non-technology shocks and a reduction of the contractionary effects of technology shocks on hours worked. Moreover, it accounts for a large share of the observed drop in output volatility after 1984 and for most of the observed changes in unconditional correlations.

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Paper provided by Bank of Italy, Economic Research and International Relations Area in its series Temi di discussione (Economic working papers) with number 800.

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Date of creation: Mar 2011
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Handle: RePEc:bdi:wptemi:td_800_11
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