Demand Shocks and the Cyclical Behavior of the Real Wage: Some International Evidence

Abstract

The focus of this investigation is on the cyclical response of the real wage to demand shocks. This response differentiates the empirical validity of major New Keynesian explanations of business cycles. The empirical evidence, across industrial countries, highlights a moderate positive correlation between nominal wage and price flexibility in response to various demand shocks. Nonetheless, higher price flexibility moderates the effect of demand shocks on real output, while higher nominal wage flexibility increases, or does not determine, the effects of demand shocks on real output across countries. An increase in the response of the real wage to demand shocks therefore exacerbates their real effect on output, as predicted by sticky-price models. Further, demand shocks do not determine the difference in wage variability. Nominal wage variability increases, in turn, output variability across countries. In contrast, demand shocks differentiate price variability. Price variability moderates, in turn, output variability across countries.