Robustnessandrealconsequencesofnominalwagerigidity.PDFVIP

ARTICLE IN PRESS Journal of Monetary Economics 52 (2005) 779–804 ./locate/jme Robustness and real consequences of nominal wage rigidity $ Ernst Fehr, Lorenz Goette Institute for Empirical Research in Economics, University of Zurich, 8006 Zurich, Switzerland Received 11 October 2002; received in revised form 3 March 2005; accepted 7 March 2005 Abstract Nominal wage rigidity has been shown to exist in periods of high inflation, while reduction in nominal pay has been hypothesized to occur in times of lo winflation. Nominal wage rigidity would therefore become irrelevant because there is little need to cut nominal pay under high inflation, while the necessary cuts would occur under lo winflation. We test this hypothesis by examining Swiss data in the 1990s, where wage inflation was low. Nominal wage rigidity proves robust in a low inflation environment, constituting a considerable obstacle to real wage adjustments. Real wages would indeed respond to unemployment without downward nominal rigidity. Moreover, wage sweep-ups caused by nominal rigidity correlate strongly to unemployment, suggesting downward nominal wage rigidity fuels unemployment. r 2005 Elsevier B.V. All rights reserved. JEL classification: J30; E31; E52 Keywords: Wages; Nominal rigidity; Inflation; Unemployment $ We thank our discussants, Jordi Gali and Phillip Harms, and the participants at the 2002 JME/Study Center Gerzensee Conference on Behavioral Macroeconomics for valuable comments. George Akerlof, Paul Devereux, William Dickens, Reto Follmi, Rafael Lalive, Ulrich Muller, George Perry, John Shea,¨ ¨ Robert Trachsel, Michael Waldman, Beth Ann Wilson, and Josef Zweimul