Nominal Wage Rigidity Research Articles

Anatomy of Wage Rigidity in China: Lessons from the Global Financial Crisis for Post-pandemic Recovery

This study examines the extent and cause of Chinese firms’ labour cost adjustment during the 2008 global financial crisis (GFC). First, we confirm that some typical features of downward nominal wage rigidity during the recession period coincide with the implementation of the Labour Contract Law, covering wages and social security payments. Second, we find that firms with higher shares of casual workers could lower their labour cost more effectively. The overall results demonstrate that the Quantitative Easing programme was necessary for counteracting the economic downturn during the GFC. Therefore, the length of this on-going crisis would be affected by wage rigidity in the economy. This study has implications for addressing the economic downturn in China following the COVID-19 pandemic, which is characterised by a high level of unemployment.

Asymmetric Effects of Monetary Policy on Firms

AbstractThis paper documents firm‐level evidence on the asymmetric effects of monetary policy in the United States. Focusing on the 1980q3–2019q4 period, I find that monetary tightenings show larger effects on firms' employment and sales than monetary easings. In comparison, investment rate does not generate significant asymmetry in response to sign‐dependent monetary policy shocks. I interpret these findings in the context of downward nominal wage rigidity and investment irreversibility channels. Furthermore, I exploit cross‐sectional variation and show that employment of small, nondividend payer, low credit rating, and young firms displays larger contractions in response to a monetary tightening.

Downward Nominal Wage Rigidity and Fiscal Policy in a Monetary Union

Downward Nominal Wage Rigidity and Fiscal Policy in a Monetary Union

Reprint of: Quantifying the Germany shock: Structural labor-market reforms and spillovers in a currency union

We examine the effects of unilateral structural reforms within a currency union. Focusing on the surge of German competitiveness following the introduction of the Euro, we first provide reduced-form causal evidence supporting the notion that German structural labor-market reforms in the early 2000s led to a crowding-out of manufacturing employment in other Eurozone economies. To assess the impact of this German competitiveness shock, we build a quantitative multi-sector trade model that features downward nominal wage rigidities, endogenous labor supply, unemployment-insurance benefits and international savings. The fixed nominal exchange rate can create binding nominal rigidities in response to a foreign real supply shock – like the one prompted by the German reforms – resulting in significant contraction of manufacturing sectors and increased involuntary unemployment across other Eurozone countries. We consider a number of counterfactual scenarios, such as the impact of German labor-market reforms in the absence of a fixed exchange-rate regime, the role of coordinated reforms within the Eurozone and a higher average inflation rate.

Quantifying the Germany shock: Structural labor-market reforms and spillovers in a currency union

We examine the effects of unilateral structural reforms within a currency union. Focusing on the surge of German competitiveness following the introduction of the Euro, we first provide reduced-form causal evidence supporting the notion that German structural labor-market reforms in the early 2000s led to a crowding-out of manufacturing employment in other Eurozone economies. To assess the impact of this German competitiveness shock, we build a quantitative multi-sector trade model that features downward nominal wage rigidities, endogenous labor supply, unemployment-insurance benefits and international savings. The fixed nominal exchange rate can create binding nominal rigidities in response to a foreign real supply shock – like the one prompted by the German reforms – resulting in significant contraction of manufacturing sectors and increased involuntary unemployment across other Eurozone countries. We consider a number of counterfactual scenarios, such as the impact of German labor-market reforms in the absence of a fixed exchange-rate regime, the role of coordinated reforms within the Eurozone and a higher average inflation rate.

Wage Rigidity and Employment Outcomes: Evidence from Administrative Data

This paper examines the relationship between downward nominal wage rigidity and employment outcomes using linked employer-employee data. Wage rigidity prevents 27.1 percent of counterfactual wage cuts, with a standard deviation of 19.2 percent across establishments. An establishment with the sample-average level of wage rigidity is predicted to have a 3.3 percentage point higher layoff rate, a 7.4 percentage point lower quit rate, and a 2.0 percentage point lower hire rate. Estimating a structural model by indirect inference implies that the cost of a nominal wage cut is 33 percent of an average worker’s annual compensation. (JEL E24, J23, J31, J63, M51)

When are tax multipliers large?

I show that the US tax multiplier depends on the direction of the tax change. The tax multiplier is significantly larger (in absolute value) for tax hikes than for tax cuts – regardless of whether I identify tax shocks via (i) the narrative approach or (ii) sign restrictions. The tax hike multiplier is strongly pro-cyclical, i.e., substantially larger in expansions. Variation in the tax cut multiplier over the business cycle is milder and statistically insignificant. A simple business cycle model with downward nominal wage rigidities can explain these results.

Endogenous Labor Supply in an Estimated New-Keynesian Model: Nominal versus Real Rigidities

The deep deterioration in the labor market during the Great Recession, the subsequent slow recovery, and the missing disinflation are hard to reconcile for standard macroeconomic models. We develop and estimate a New-Keynesian model with financial frictions, search and matching frictions in the labor market, and endogenous intensive and extensive labor supply decisions. We conclude that the estimated combination of the low degree of nominal wage rigidities and high degree of real wage rigidities, together with the small role of pre-match costs relative to post-match costs, are key in successfully forecasting the slow recovery in unemployment and the missing disinflation in the aftermath of the Great Recession. We find that endogenous labor supply data are very informative about the relative degree of nominal and real wage rigidities and the slope of the Phillips curve. We also find that none of the model-based labor market gaps are a sufficient statistic of labor market slack, but all contain relevant information about the state of the economy summarized in a new indicator for labor market slack we put forward.

Optimal monetary policy in developing countries: The role of informality

In this paper, I analyze optimal monetary policy in developing countries whose labor markets are characterized by the presence of a large informal sector. I develop a closed economy model with nominal price and wage rigidities, search and matching frictions, and a dual labor market: a formal one characterized by matching frictions and nominal wage rigidities, and an informal one where wages are fully flexible. Under this framework, a trade-off between price and wage inflation emerges. I find that informality increases the response of price and wage inflation to aggregate productivity shocks. As a result, the presence of an informal sector increases the inefficient fluctuations of labor market variables, such as unemployment, labor market tightness, and formal hiring rate. I find that optimal policy with informality features significant deviations from price stability in response to aggregate productivity shocks.

The Long-Run Real Effects of Banking Crises: Firm-Level Investment Dynamics and the Role of Wage Rigidity

I study the long-run effects of credit market disruptions on real firm outcomes and how these effects depend on nominal wage rigidity at the firm level. Exploiting variation in firms' refinancing needs during the global financial crisis, I trace out firms' investment and growth trajectories in response to a credit supply shock. Financially shocked firms exhibit a temporary investment gap for two years, resulting in a persistent accumulated growth gap six years after the crisis. Shocked firms with rigid wages exhibit a significantly steeper drop in investment and an additional long-run growth gap relative to shocked firms with flexible wages.

Labor Market Effects of Global Supply Chain Disruptions

We examine the labor market consequences of recent global supply chain disruptions induced by COVID-19. Specifically, we consider a temporary increase in international trade costs similar to the one observed during the pandemic and analyze its effects on labor market outcomes using a quantitative trade model with downward nominal wage rigidities. Even omitting any health related impacts of the pandemic, the increase in trade costs leads to a temporary but prolonged decline in U.S. labor force participation. However, there is a temporary increase in manufacturing employment as the United States is a net importer of manufactured goods, which become costlier to obtain from abroad. By contrast, service and agricultural employment experience temporary declines. Nominal frictions lead to temporary unemployment when the shock dissipates, but this depends on the degree of monetary accommodation. Overall, the shock results in a 0.14% welfare loss for the United States. The impact on labor force participation and welfare across countries varies depending on the initial degree of openness and sectoral deficits.

Downward Nominal Wage Rigidity and Determinacy of Equilibrium

AbstractIt is well known in the literature that there is a tension between the frequency and duration of the zero lower bound (ZLB) on the nominal interest rate and the determinacy of equilibrium. In this short paper, I show that the presence of downward nominal wage rigidity (DNWR) resolves the tension by preventing a vicious cycle of price declines and output contractions under the ZLB. Consequently, the model with DNWR can replicate the long‐lived ZLB episodes observed in the data. It also implies a plausible size of output and inflation declines at the ZLB.

Money demand by firms, labor market frictions, and optimal long-run inflation

Abstract Optimal monetary policy, under flexible and sticky prices, and sticky nominal wages are studied in the canonical matching model of the labor market with a working capital channel. A money demand by firms is motivated by the fact that a significant amount of M1 is held by firms. As a result of the working capital, the Ramsey-optimal monetary policy calls for inflation when employment is above the socially efficient level and for deflation when it is below that level. This result holds under flexible wages as well as nominal wage rigidities. In other words, to improve labor market efficiency, deflation is necessary to “grease the wheels of the labor market.” Although there is no relationship between optimal monetary policy and the market tightness under flexible prices, a long-run and mainly negative relationship between the optimal inflation rate and the equilibrium tightness emerges under sticky prices.

Downward Nominal Wage Rigidity and Optimal Inflation Target

Downward Nominal Wage Rigidity and Optimal Inflation Target

Downward Nominal Wage Rigidity and Asymmetric Effects of Monetary Policy

Downward Nominal Wage Rigidity and Asymmetric Effects of Monetary Policy

Liquidity-constrained consumers and optimal monetary policy in a currency union

This paper examines optimal monetary policy in a currency union model with liquidity-constrained (LC) consumers. The result demonstrates that given LC consumers in the home country, the response of macroeconomic variables to a foreign structural shock is generally dampened as a share of foreign LC consumers increases. This paper finds that the costs of discretionary policy are generally not greater in a currency union in which LC consumers exist in both countries. We address that the presence of nominal wage rigidity significantly lowers welfare losses in our model.

The extent of downward nominal wage rigidity: New evidence from payroll data

We use over a decade of representative payroll data from Great Britain to study the nominal wage changes of employees who stayed in the same job for at least one year. We show that basic hourly pay drives the cyclicality of marginal labour costs, making this the most relevant measure of wages for macroeconomic models that incorporate wage rigidity. Basic hourly pay adjusts much less frequently than previously thought in Britain, particularly in small firms. We find that firms compress wage growth when inflation is low, which indicates that downward rigidity constrains firms' wage setting. We demonstrate that the empirical extent of downward nominal wage rigidity (DNWR) can theoretically cause considerable long-run output losses. Combined, our results all point to the importance of including DNWR in macroeconomic and monetary policy models.

Yield curve and the macroeconomy: Evidence from a DSGE model with housing

The slope of the yield curve has long been found to be a useful predictor of future economic activities, but the relationship is unstable. One change we have identified in this paper is that, between the early 1990s and the collapse of the housing market in 2007, movements at the long end of the yield curve have an increase in predictive power. We use a medium-scale DSGE model with a housing sector and a yield curve as a guide to find out the sources of such change. The model implies that an increase in the short-term interest rate and a decrease in the long-term interest rate have different impacts on the economy, and to use the slope as a predictor one needs to distinguish movements at the two ends of the yield curve. Based on simulated data from the model, we find that nominal wage rigidities and the capital adjustment costs are closely related to the predictive power of the yield curve. This result is further confirmed with actual data.

Sticky wages and the Great Depression: evidence from the United Kingdom

Abstract How sticky were wages during the Great Depression? Although classic accounts emphasise the importance of nominal rigidity in amplifying deflationary shocks, the evidence is limited. In this paper, I calculate the degree of nominal wage rigidity in the United Kingdom between the wars using new granular data covering millions of wages. I find that nominal wages changed infrequently but that wage cuts were more common than wage rises on average. Nominal wage adjustment fluctuated over time and by state, so that in 1931 amid falling output and prices more than one-third of workers received wage cuts.

Downward Nominal Wage Rigidity and Inflation Dynamics during and after the Great Recession

AbstractIn this paper, I develop a New Keynesian model that embeds heterogeneous workers with asymmetric wage adjustment costs to address two inflation puzzles: missing deflation during the Great Recession and the subsequent missing inflation. When the wage adjustment costs are estimated according to U.S. microwage data, downward nominal wage rigidity emerges, which flattens the observed price Phillips curve during and after recessions. Endogenous evolution of the cross‐sectional wage distribution generates nonlinear dynamics including the sign, size, and state dependence. These nonlinearities enable the model to address the inflation puzzles as well as matching microevidence on wage adjustments.