The Spillover Effects of Nominal Wage Rigidity in a Multisector Economy: Note

Abstract

Although Western economies are composed of markets with differing degrees of wage-price stickiness, most analytical macromodels are not composed of distinct sectors, arld do not attempt to analyze how different sectors respond to policy actions and supply or demand shocks. Blinder and Mankiw (1984) investigate how macropolicies and shocks affect a multicontract archipelago economy composed of five sectors (islands), each characterized by different wage-price behavior. They convincingly demonstrate how heterogeneous markets pose aggregation problems for policy makers and econometricians because each market reacts differently to common shocks. However, the Blinder-Mankiw model is not really a model of an economy composed of integrated, heterogeneous markets. Their archipelago model assumes that the workers in each sector (island) consume only the product produced in their sector. A more realistic and analytically more appealing model would integrate the sectors by having each worker consume the same basket of heterogeneous goods. Under these circumstances, conditions in one sector which affect the price of that sector's output can affect wage demands (i.e., labor supply) in another sector and, thereby, the output of this other sector. Through this channel, wage-price stickiness in one sector allows aggregate demand policy and shocks to have real effects on a sector with perfectly flexible sectoral wages and prices. This result does not occur in the Blinder-Mankiw model because it lacks this type of CPI-labor supply linkage between sectors. In fact, these spillover effects have not been directly addressed by the existing literature. For purposes of brevity, only aggregate demand shocks will be considered in a closed economy consisting of only two sectors: one having goods and labor markets which clear instantaneously (henceforth, the classical or Walrasian sector), and the