Why Does the Cyclical Behavior of Real Wages Change Over Time?

Abstract

The cyclical behavior of real wages has evolved from mildly countercyclical during the interwar period to modestly procyclical in the postwar era. This paper presents a general-equilibrium business-cycle model that helps explain the evolution. In the model, changes in the real wage cyclicality arise from interactions between nominal wage and price rigidities and an evolving input-output structure.

Monetary policy and real wage cyclicality

“…Also, the period 1972-1992, characterized by sizeable supply shocks, strong anti in ‡ation policy followed by further emphasis on in ‡ation stability, also …ts the story that under such conditions we should be observing a substantial increase in real wage procyclicality. More importantly, unlike Huang, Liu and Phaneuf (2004) and the earlier studies, our results are also consistent with the drop in real wage procyclicality during the relatively stable in ‡ation periods of the post 1980s when less contractionary monetary intervention was required. Krause and Lubik (2007) Blanchard and Gali (2007), and Panel B reports estimates with dummy variables for supply shock and demand shock episodes identified based on the market for crude oil, as described in Appendix B.…”

“…4 This is consistent with the …ndings by Huang, Liu and Phaneuf (2004), that changes in the size of the elasticity of output with respect to their intermediate input are crucial for the direction of real wage cyclicality. 5 Our results are also consistent with Basu and Fernald (1997) in that the assumption of increasing returns to scale can overturn the countercyclicality of real wage during demand shocks to real wage procyclicality.…”

“…For example, Basu and Taylor (1999), indicate that the correlation between real wages and aggregate output in the U.S. economy has changed from -0.444 in the interwar period , to 0.381 during the Bretton Woods period , and further to about 0.503 during the more recent period of ‡oating exchange rates . Huang, Liu and Phaneuf (2004), suggest that this is di¢ cult to be explained purely by aggregate supply shocks alone and they attribute this to an ever increasing use of intermediate goods in the US. We too share this view, because as we show the nature of aggregate shocks alone could not explain an ever increasing trend in real wage procyclicality.…”

“…Some, for example, choose to focus on the relative degree of nominal price and wage rigidities, where traditionally a higher degree of nominal wage rigidity, relatively to price rigidity, implies a higher real wage countercyclicality during demand shocks, though results tend to be more ambiguous following a supply shock, (i.e. Huang and Liu 2002, Huang, Liu and Phaneuf 2004, Malley, Muscatelli and Woitek 2005; or on the role of various production technologies that a¤ect the cyclicality of real wage (i.e. Liu 2002, Huang, Liu andPhaneuf, 2004 wages are stickier than prices.…”

“…Huang and Liu 2002, Huang, Liu and Phaneuf 2004, Malley, Muscatelli and Woitek 2005; or on the role of various production technologies that a¤ect the cyclicality of real wage (i.e. Liu 2002, Huang, Liu andPhaneuf, 2004 wages are stickier than prices. As we show below, this is su¢ cient to capture the well-documented evidence (see also above) that aggregate demand shocks are associated with countercyclical real wages whereas aggregate supply shocks are associated with procyclical real wages.…”