Wage Dynamics: Reconciling Theory and Evidence

14 Pages Posted: 21 Jun 1999 Last revised: 7 May 2000

See all articles by Olivier J. Blanchard

Olivier J. Blanchard

National Bureau of Economic Research (NBER); Peter G. Peterson Institute for International Economics

Lawrence F. Katz

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: February 1999

Abstract

U.S. macroeconomic evidence shows a negative relation between the rate of change of wages and unemployment. In contrast, most theories of wage determination imply a negative relation between the level of wages and unemployment. In this paper, we ask whether one can reconcile the empirical evidence with theoretical wage relations. We reach three main conclusions. First, we derive the condition under which the two can indeed be reconciled. We show the constraints that such a condition imposes on the determinants of workers' reservation wages as well as the relative importance of workers' outside options as opposed to match specific productivity in wage determination. Second, in the light of this condition, we reinterpret the presence of an "error correction" term in macroeconomic wage relations for most European economies but not in the United States. Third, we show that whether this condition holds or not has important implications for the effects of a number of variables -- from real interest rates to oil prices to payroll taxes -- on the natural rate of unemployment.

Suggested Citation

Blanchard, Olivier J. and Katz, Lawrence F., Wage Dynamics: Reconciling Theory and Evidence (February 1999). NBER Working Paper No. w6924. Available at SSRN: https://ssrn.com/abstract=148609

Olivier J. Blanchard (Contact Author)

National Bureau of Economic Research (NBER) ( email )

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Peter G. Peterson Institute for International Economics ( email )

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Lawrence F. Katz

Harvard University - Department of Economics ( email )

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HOME PAGE: http://www.economics.harvard.edu/faculty/katz/katz

National Bureau of Economic Research (NBER) ( email )

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