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Does Inflation "Grease the Wheels of the Labor Market"?

  • David Card
  • Dean Hyslop

If nominal wages are downward rigid, moderate levels of inflation may improve labor market efficiency by facilitating real wage cuts. In this paper we attempt to test the hypothesis that downward real wage changes occur more readily in higher-inflation environments. Using individual wage change data from two sources, we find that about 6-10 percent of workers experience nominally rigid wages in a 10- percent inflation environment. This proportion rises to over 15 percent at a 5 percent inflation rate. We use the assumption of symmetry to generate counterfactual distributions of real wage changes in the absence of rigidities. These counterfactual distributions suggest that a 1 percent increase in the inflation rate reduces the fraction of workers with downward-rigid wages by about 0.8 percent, and allows real wages to fall about 0.06 percent faster. A market- level analysis of the effects of nominal rigidities, based on wage growth and unemployment at the state level, is less conclusive. We find only a weak statistical relationship between the rate of inflation and the pace of relative wage adjustments across local labor markets.

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File URL: http://www.nber.org/papers/w5538.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5538.

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Date of creation: Apr 1996
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Publication status: published as Reducing Inflation: Motivation and Strategy, C. Romer and D. Romer, eds.,(Chicago: University of Chicago Press, 1997)
Handle: RePEc:nbr:nberwo:5538
Note: EFG LS ME
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  1. David Card, 1995. "The Wage Curve: A Review," Working Papers 722, Princeton University, Department of Economics, Industrial Relations Section..
  2. Solon, Gary & Barsky, Robert & Parker, Jonathan A, 1994. "Measuring the Cyclicality of Real Wages: How Important Is Composition Bias?," The Quarterly Journal of Economics, MIT Press, vol. 109(1), pages 1-25, February.
  3. Blanchflower, D. & Oswald, A., 1989. "The Wage Curve," Papers 340, London School of Economics - Centre for Labour Economics.
  4. Krueger, Alan B & Summers, Lawrence H, 1988. "Efficiency Wages and the Inter-industry Wage Structure," Econometrica, Econometric Society, vol. 56(2), pages 259-93, March.
  5. Robert J. Shiller, 1996. "Why Do People Dislike Inflation?," NBER Working Papers 5539, National Bureau of Economic Research, Inc.
  6. Brown, James N & Light, Audrey, 1992. "Interpreting Panel Data on Job Tenure," Journal of Labor Economics, University of Chicago Press, vol. 10(3), pages 219-57, July.
  7. Card, David, 1996. "The Effect of Unions on the Structure of Wages: A Longitudinal Analysis," Econometrica, Econometric Society, vol. 64(4), pages 957-79, July.
  8. Kahn, Shulamit, 1997. "Evidence of Nominal Wage Stickiness from Microdata," American Economic Review, American Economic Association, vol. 87(5), pages 993-1008, December.
  9. 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.).
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