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What if Wages Fell During a Recession?

Author

Listed:
  • Joy A. Buchanan

    (Brock School of Business, Samford University)

  • Daniel Houser

    (Interdisciplinary Center for Economic Science and Department of Economics, George Mason University)

Abstract

Many economies exhibit downward wage rigidity. Surveys of managers by Bewley [1999] and Campbell and Kamlani [1997] indicate that employers hold wages rigid because they believe morale will suffer after a wage cut. Otherwise, there is little evidence for how employers’ beliefs about workers contribute to wage rigidity and whether those beliefs are accurate. We demonstrate that effort falls after workers experience a wage cut and also that workers form reference points from wage contracts. Despite this partial confirmation of the †morale theory†as an explanation for wage rigidity, half of the employers in our experiment cut wages and lose money as a result. Because our design allows us to compare beliefs and effort precisely, we find that when employers don’t believe the morale theory they will not hold wages rigid. In a treatment where a recession is offset by nominal inflation, real wage cuts do not have a significant effect. Loss averse employers are less likely to cut wages and more likely to correctly predict the negative effect of wage cuts.

Suggested Citation

  • Joy A. Buchanan & Daniel Houser, 2017. "What if Wages Fell During a Recession?," Working Papers 1062, George Mason University, Interdisciplinary Center for Economic Science, revised Aug 2017.
    • Handle: RePEc:gms:wpaper:1062
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    References listed on IDEAS

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    Cited by:

    1. Diriwaechter, Patric & Shvartsman, Elena, 2018. "The anticipation and adaptation effects of intra- and interpersonal wage changes on job satisfaction," Journal of Economic Behavior & Organization, Elsevier, vol. 146(C), pages 116-140.
    2. Grundmann, Susanna & Giamattei, Marcus & Lambsdorff, Johann Graf, 2019. "Intentions rather than money illusion – Why nominal changes induce real effects," European Economic Review, Elsevier, vol. 119(C), pages 166-178.

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    More about this item

    Keywords

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    JEL classification:

    • C92 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Group Behavior
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • J31 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Wage Level and Structure; Wage Differentials

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