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Identifying Inflation's Grease and Sand Effects in the Labor Market

  • Erica L. Groshen
  • Mark E. Schweitzer

Inflation has been accused of causing distortionary price and wage fluctuations (sand) as well as lauded for facilitating adjustments to shocks when wages are rigid downwards (grease). This paper investigates whether these two effects can be distinguished from each other in a labor market by the following identification strategy: inflation-induced deviations among employers' mean wage changes represent unintended intramarket distortions (sand), while inflation-induced, inter-occupational wage changes reflect intended alignments with intermarket forces (grease). Using a unique 40-year panel of wage changes made by large mid-western employers, we find a wide variety of evidence to support the identification strategy. We also find some indications that occupational wages in large firms gained flexibility in the past four years. These results strongly support other findings that grease and sand effects exist, but also suggest that they offset each other in a welfare sense and in unemployment effects. Thus, at levels up to five percent, the net impact of inflation on unemployment is beneficial but statistically indistinguishable from zero. It turns detrimental after that. When positive, net benefits never exceed a tenth of gross benefits.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6061.

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Date of creation: Jun 1997
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Publication status: published as The Costs and Effects of Price Stability. Feldstein, Martin, ed., Chicago: The University of Chicago Press, 1999, pp.273-308.
Handle: RePEc:nbr:nberwo:6061
Note: ME
Contact details of provider: Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
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  1. Killingsworth, Mark R. & Heckman, James J., 1987. "Female labor supply: A survey," Handbook of Labor Economics, in: O. Ashenfelter & R. Layard (ed.), Handbook of Labor Economics, edition 1, volume 1, chapter 2, pages 103-204 Elsevier.
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  3. Tobin, James, 1972. "Inflation and Unemployment," American Economic Review, American Economic Association, vol. 62(1), pages 1-18, March.
  4. McLaughlin, Kenneth J., 1994. "Rigid wages?," Journal of Monetary Economics, Elsevier, vol. 34(3), pages 383-414, December.
  5. 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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  8. Haley, James, 1990. " Theoretical Foundations for Sticky Wages," Journal of Economic Surveys, Wiley Blackwell, vol. 4(2), pages 115-55.
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  10. 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.
  11. Erica L. Groshen & Mark E. Schweitzer, 1994. "The effects of inflation on wage adjustments in firm-level data: grease or sand?," Working Paper 9418, Federal Reserve Bank of Cleveland.
  12. Erica Groshen & David Levine, 1998. "The rise and decline(?) of U.S. internal labor markets," Research Paper 9819, Federal Reserve Bank of New York.
  13. Javier Andres & Ignacio Hernando, 1997. "Does Inflation Harm Economic Growth? Evidence for the OECD," NBER Working Papers 6062, National Bureau of Economic Research, Inc.
  14. George A. Akerlof & William R. Dickens & George L. Perry, 1996. "The Macroeconomics of Low Inflation," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 27(1), pages 1-76.
  15. Erica Groshen, 1996. "American employer salary surveys and labor economics research: issues and contributions," Research Paper 9604, Federal Reserve Bank of New York.
  16. Kahn, Shulamit, 1997. "Evidence of Nominal Wage Stickiness from Microdata," American Economic Review, American Economic Association, vol. 87(5), pages 993-1008, December.
  17. Allan Drazen & Daniel S. Hamermesh, 1986. "Inflation and Wage Dispersion," NBER Working Papers 1811, National Bureau of Economic Research, Inc.
  18. Alan S. Blinder & Don H. Choi, 1989. "A Shred of Evidence on Theories of Wage Stickiness," NBER Working Papers 3105, National Bureau of Economic Research, Inc.
  19. 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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