Performance Pay and Shifts in Macroeconomic Correlations

45 Pages Posted: 16 May 2011

Multiple version iconThere are 2 versions of this paper

Date Written: March 15, 2011

Abstract

A coincidence in time between the volatility break associated with the "Great Moderation" and large changes in the pattern of conditional and unconditional correlations between output, hours and labor productivity was detected by GalĂ­ and Gambetti (2009). We provide a novel explanation for these findings, based on the major changes that occurred in the U.S. design of labor compensation around the mid-1980s. These include a substantial increase in the incidence of performance pay coupled with a higher responsiveness of real wages to the business cycle. We capture this shift in the structure of labor compensation in a Dynamic New Keynesian (DNK) model and show that, by itself, it generates the disappearance of the procyclical response of labor productivity to non-technology shocks and a reduction of the contractionary effects of technology shocks on hours worked. Moreover, it accounts for a large share of the observed drop in output volatility after 1984 and for most of the observed changes in unconditional correlations.

Keywords: procyclical productivity, wage rigidities, performance pay

JEL Classification: E24, E32, J3, J22

Suggested Citation

Nucci, Francesco and Riggi, Marianna, Performance Pay and Shifts in Macroeconomic Correlations (March 15, 2011). Bank of Italy Temi di Discussione (Working Paper) No. 800. Available at SSRN: https://ssrn.com/abstract=1832346 or http://dx.doi.org/10.2139/ssrn.1832346

Francesco Nucci

University of Rome I ( email )

Piazzale Aldo Moro
Rome, 00185
Italy
+39 06 4991 0847 (Phone)
+39 06 445 3246 (Fax)

Marianna Riggi (Contact Author)

Bank of Italy ( email )

Via Nazionale 91
00184 Roma
Italy

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