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

  • Erica L. Groshen
  • Mark E. Schweitzer

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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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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  1. 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.
  2. David Card & Dean Hyslop, 1997. "Does Inflation "Grease the Wheels of the Labor Market"?," NBER Chapters, in: Reducing Inflation: Motivation and Strategy, pages 71-122 National Bureau of Economic Research, Inc.
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  4. 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.
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  6. 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.
  7. 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.).
  8. Blinder, Alan S & Choi, Don H, 1990. "A Shred of Evidence on Theories of Wage Stickiness," The Quarterly Journal of Economics, MIT Press, vol. 105(4), pages 1003-15, November.
  9. Erica L. Groshen & Mark E. Schweitzer, 1997. "Identifying inflation's grease and sand effects in the labor market," Staff Reports 31, Federal Reserve Bank of New York.
  10. Haley, James, 1990. " Theoretical Foundations for Sticky Wages," Journal of Economic Surveys, Wiley Blackwell, vol. 4(2), pages 115-55.
  11. David Card, 1988. "Unexpected Inflation, Real Wages, and Employment Determination in Union Contracts," Working Papers 612, Princeton University, Department of Economics, Industrial Relations Section..
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  13. Laurence Ball & N. Gregory Mankiw, 1994. "A sticky-price manifesto," Proceedings, Federal Reserve Bank of Dallas, issue Apr.
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  18. 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.
  19. 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.
  20. Hartman, Richard, 1991. "Relative Price Variability and Inflation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(2), pages 185-205, May.
  21. 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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  24. 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.
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  26. Friedman, Milton, 1977. "Nobel Lecture: Inflation and Unemployment," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 451-72, June.
  27. 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.
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