Working Paper: NBER ID: w22279
Authors: Susanto Basu; Christopher L. House
Abstract: Modern monetary business-cycle models rely heavily on price and wage rigidity. While there is substantial evidence that prices do not adjust frequently, there is much less evidence on whether wage rigidity is an important feature of real world labor markets. While real average hourly earnings are not particularly cyclical, and do not react significantly to monetary policy shocks, systematic changes in the composition of employed workers and implicit contracts within employment arrangements make it difficult to draw strong conclusions about the importance of wage rigidity. We augment a workhorse monetary DSGE model by allowing for endogenous changes in the composition of workers and also by explicitly allowing for a difference between allocative wages and remitted wages. Using both individual-level and aggregate data, we study and extend the available evidence on the cyclicality of wages and we pay particular attention to the response of wages to identified monetary policy shocks. Our analysis suggests several broad conclusions: (i) in the data, composition bias plays a modest but noticeable role in cyclical compensation patterns; (ii) empirically, both the wages for newly hired workers and the "user cost of labor" respond strongly to identified monetary policy innovations; (iii) a model with implicit contracts between workers and firms and a flexible allocative wage replicates these patterns well. We conclude that price rigidity likely plays a substantially more important role than wage rigidity in governing economic fluctuations.
Keywords: allocative wages; remitted wages; monetary policy; wage rigidity; business cycles
JEL Codes: E24; E3; E31; E32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| monetary policy shocks (E39) | wage adjustments (J31) |
| composition of the workforce (J21) | cyclicality of wages (J31) |
| price rigidity (D41) | economic fluctuations (E32) |
| wage rigidity (J31) | economic fluctuations (E32) |
| monetary policy shocks (E39) | wages for newly hired workers (J31) |
| monetary policy shocks (E39) | user cost of labor (J30) |