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Inflation and Wage Dispersion

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  • Allan Drazen
  • Daniel S. Hamermesh

Abstract

A large body of empirical work has demonstrated that higher inflation, especially when it is unexpected, leads to greater dispersion in the distribution of price changes across subaggregates. A sparse and more recent literature suggests exactly the opposite effects on the distribution of wage changes. This study first reconciles these apparently opposite results using a model in which shocks to the economy can affect both wages and prices and the demand for indexing. If the positive effect of shocks on the demand for indexing is sufficiently large, the dispersion of changes in wages or prices will be reduced even though the shocks' direct effect is to increase this dispersion. Implicitly from the evidence, this offset is large enough in wage-setting, but not so large in price determination. Additional evidence on the relationship between inflation and the dispersion of wage changes is provided by empirical work for 14 Israeli manufacturing industries, 1956-82. The results suggest that in Israel, just as in the United States (on which previous work has been conducted) with its much less rapid and variable inflation, dispersion also decreased with unexpected price inflation.

Suggested Citation

  • Allan Drazen & Daniel S. Hamermesh, 1986. "Inflation and Wage Dispersion," NBER Working Papers 1811, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:1811
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    File URL: http://www.nber.org/papers/w1811.pdf
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    References listed on IDEAS

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    1. Cukierman, Alex & Wachtel, Paul, 1982. "Relative Price Variability and Nonuniform Inflationary Expectations," Journal of Political Economy, University of Chicago Press, vol. 90(1), pages 146-157, February.
    2. Parks, Richard W, 1978. "Inflation and Relative Price Variability," Journal of Political Economy, University of Chicago Press, vol. 86(1), pages 79-95, February.
    3. Fischer, Stanley, 1982. "Relative price variability and inflation in the United States and Germany," European Economic Review, Elsevier, vol. 18(2), pages 171-196.
    4. Fischer, Stanley, 1982. "Relative price variability and inflation in the United States and Germany," European Economic Review, Elsevier, vol. 18(1), pages 171-196.
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    Cited by:

    1. Erica Groshen & Mark Schweitzer, 1999. "Identifying Inflation's Grease and Sand Effects in the Labor Market," NBER Chapters,in: The Costs and Benefits of Price Stability, pages 273-314 National Bureau of Economic Research, Inc.
    2. Erica L. Groshen & Mark E. Schweitzer, 1994. "The effects of inflation on wage adjustments in firm-level data: grease or sand?," Working Papers (Old Series) 9418, Federal Reserve Bank of Cleveland.
    3. Erica L. Groshen & Mark E. Schweitzer, 1996. "Macro- and microeconomic consequences of wage rigidity," Working Papers (Old Series) 9607, Federal Reserve Bank of Cleveland.

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