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Wage formation under low inflation

This paper reviews the literature on the effects of low steady-state inflation on wage formation, focusing on four different effects. First, under low inflation, downward nominal wage rigidity (DNWR) may prevent real wage cuts that would have happened had inflation been higher. Second, wages (and prices) are given in nominal contracts, and inflation affects both how often wages are adjusted, and to what extent wages are set in a forward-looking manner. Third, incomplete labour contracts may provide workers with scope for inflicting costs on the firm without violating the contract, thus forcing the firm to accept a rise in nominal wages. Fourth, if effort depends on wages relative to a reference level, and workers and firms underweight inflation when updating the reference level, positive but moderate inflation may reduce wage pressure. The paper ends by a brief survey of empirical evidence, and a discussion of whether labour markets may adapt to a low inflation environment.

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File URL: http://www.sv.uio.no/econ/english/research/unpublished-works/working-papers/pdf-files/2004/Memo-09-2004.pdf
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Paper provided by Oslo University, Department of Economics in its series Memorandum with number 09/2004.

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Length: 22 pages
Date of creation: 26 Oct 2004
Date of revision:
Handle: RePEc:hhs:osloec:2004_009
Contact details of provider: Postal: Department of Economics, University of Oslo, P.O Box 1095 Blindern, N-0317 Oslo, Norway
Phone: 22 85 51 27
Fax: 22 85 50 35
Web page: http://www.oekonomi.uio.no/indexe.html
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