Working Paper: NBER ID: w12611
Authors: Michael W. Elsby
Abstract: The existence of downward nominal wage rigidity has been abundantly documented, but what are its economic implications? This paper demonstrates that, even when wages are allocative, downward wage rigidity can be consistent with weak macroeconomic effects. Firms have an incentive to compress wage increases as well as wage cuts when downward wage rigidity binds. By neglecting compression of wage increases, previous literature may have overstated the costs of downward wage rigidity to firms. Using microdata from the US and Great Britain, I find that evidence for compression of wage increases when downward wage rigidity binds. Accounting for this reduces the estimated increase in aggregate wage growth due to wage rigidity to be much closer to zero. These results suggest that downward wage rigidity may not provide a strong argument against the targeting of low inflation rates.
Keywords: downward nominal wage rigidity; wage growth; inflation; macro-economic implications
JEL Codes: E24; E31; J30; J41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Downward nominal wage rigidity (J31) | wage compression (J31) |
| wage compression (J31) | wage-setting behavior (J31) |
| Downward nominal wage rigidity (J31) | perceived costs to firms (D21) |
| Downward nominal wage rigidity (J31) | aggregate wage growth (O40) |