Nominal and Real Wage Cyclicality during the Interwar Period

Abstract

Although there have been numerous attempts to study the cyclicality of real wages in the U.S., no consensus has formed as to the implications of the various findings for business cycle theory. This paper will demonstrate that separating the real wage into its nominal and price level components can shed new light on the interwar U.S. labor market. More specifically, we will show that an evolution from a relatively laissez-faire labor market during the 1920s, to a more highly regulated labor market during the 1930s, may have resulted in a more countercyclical real wage rate. If we could be certain that equilibrium business cycle models provided the correct specification of the labor market then interpretation of real wage cyclicality would be relatively straightforward; during periods dominated by labor demand shocks real wages would move procyclically and during periods dominated by labor supply shocks real wages would move countercyclically. In a disequilibrium model context, however, interpretation of real wage cyclicality is much more problematic. If nominal wages are sticky, then unanticipated price level changes can induce countercyclical real wage movements that mimic the real wage movements generated by shifts in the supply of labor. Perhaps the most famous (and controversial) example occurred during the first three years of the Great Depression when a massive decline in hours worked and production was associated with a sharp increase in the aggregate real wage rate (see Figure 1). Even greater complexity results from governmental attempts to influence the aggregate nominal wage. Policies that attempt to artificially change the nominal wage rate can result in either procyclical or countercyclical real wages depending on whether the direct impact of changes in the price of labor on the quantity of labor demanded outweighs the impact of wage changes on aggregate demand, and output. Separating the aggregate real wage rate into its nominal and price level components will allow us to discriminate between these two hypotheses. If labor markets are correctly characterized by equilibrium models, then the price level and real wage are determined independently and separating the real wage into its nominal and price