Currency crises and dynamics of real wages

Abstract

How do currency crises impact real wages? Nominal wage rigidity leads to a large and temporary decline in real wages. Also, labor productivity tends to decline during crisis leading to a similar decline in real wages. Finally, currency crises can reduce the bargaining power of labor resulting in lower real wages. Using a panel of 86 countries during 1970–2010, the author examines the dynamics of real wages and labor productivity following a large depreciation of the nominal exchange rate in the short, medium, and long run in order to determine the relative importance of each of these factors. The results indicate that in a sample of countries with median exchange rate depreciation of 56 % during crises, real wage per employee on average declines between 20 and 25 % just a year after a currency crisis. Ten years following a currency shock, real wages are still 10–20 % below the pre-crisis level. Labor productivity also declines. But, the decline in real wages is larger and more persistent. The long-lasting nature of the decline in real wages implies that factors beyond nominal wage rigidities are at work. The weak link between real wages and labor productivity during currency crises provides some suggestive evidence in favor of the ‘bargaining power’ hypothesis. The results are robust to different definitions of currency crises and estimation methods.