Nominal Wage Rigidity in the United Kingdom

Abstract

This paper studies the degree of downward rigidity in nominal wages in the United Kingdom using micro-data. Around 9% of employees who remain in the same job from one year to the next have zero pay growth. But on investigating the causes of rigidity we find that up to ninetenths can be attributed to 'symmetric' causes (such as contracts and menu costs) or to error. Thus only 1% of workers have pay that may be downwardly rigid. This suggests asymmetric, downward rigidity is not large enough to have serious macroeconomic consequences. The labour market provides almost no evidence to support a positive inflation target. The idea that nominal wages might be rigid has a long history, stretching back at least as far as Keynes (1936). In addition to any intrinsic interest in the behaviour of the price of labour, the issue has important implications for the macroeconomy. Downwardly rigid nominal wages could provide a rationale for a positive optimal rate of inflation and hence for the pursuance of a positive inflation target. As Tobin (1972) argued, if wages are rigid downwards, negative demand or positive supply shocks leave real wages higher than marginal product, resulting in unemployment. Higher inflation could alleviate this unemployment by reducing the real wage. Thus the cost of downward nominal rigidity - which can also be interpreted as the cost of very low inflation where downward rigidity exists - is unemployment. Downward rigidity implies asymmetry in wage changes: nominal wages are more likely to rise than to fall. Symmetric rigidities, whereby nominal wages are sticky in both directions, can also have detrimental macroeconomic implications. Unemployment is a feature of many models of long-term or staggered contracts (see, for example, Mankiw and Romer, 1991). However, symmetric rigidities do not have the same implications for the optimal rate of inflation: the effects of symmetric rigidities cannot be alleviated by a higher inflation rate. In this paper, nominal rigidity is taken to mean a 0% nominal pay change. Clearly wages are in some sense 'rigid' if they do not move as much as they 'should'. It is almost impossible in practice to calculate how much pay 'should' change, although a simple conception of this warranted growth might be related to the change in the individual's productivity. A 0% nominal wage change has potentially special features, however. Psychological studies, which focus on downward rigidity, suggest that zero is a barrier of special importance (Kahneman et al., 1986; Blinder and Choi, 1990). Menu costs also impart