Allocative and Remitted Wages: New Facts and Challenges for Keynesian Models

72 Pages Posted: 24 May 2016

See all articles by Susanto Basu

Susanto Basu

Boston College, College of Arts and Sciences, Department of Economics; National Bureau of Economic Research (NBER)

Christopher L. House

University of Michigan at Ann Arbor - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: May 2016

Abstract

Modern monetary business-cycle models rely heavily on price and wage rigidity. While there is substantial evidence that prices do not adjust frequently, there is much less evidence on whether wage rigidity is an important feature of real world labor markets. While real average hourly earnings are not particularly cyclical, and do not react significantly to monetary policy shocks, systematic changes in the composition of employed workers and implicit contracts within employment arrangements make it difficult to draw strong conclusions about the importance of wage rigidity. We augment a workhorse monetary DSGE model by allowing for endogenous changes in the composition of workers and also by explicitly allowing for a difference between allocative wages and remitted wages. Using both individual-level and aggregate data, we study and extend the available evidence on the cyclicality of wages and we pay particular attention to the response of wages to identified monetary policy shocks. Our analysis suggests several broad conclusions: (i) in the data, composition bias plays a modest but noticeable role in cyclical compensation patterns; (ii) empirically, both the wages for newly hired workers and the "user cost of labor" respond strongly to identified monetary policy innovations; (iii) a model with implicit contracts between workers and firms and a flexible allocative wage replicates these patterns well. We conclude that price rigidity likely plays a substantially more important role than wage rigidity in governing economic fluctuations.

Suggested Citation

Basu, Susanto and House, Christopher L., Allocative and Remitted Wages: New Facts and Challenges for Keynesian Models (May 2016). NBER Working Paper No. w22279, Available at SSRN: https://ssrn.com/abstract=2783193

Susanto Basu (Contact Author)

Boston College, College of Arts and Sciences, Department of Economics ( email )

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Chestnut Hill, MA 02467-3806
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National Bureau of Economic Research (NBER) ( email )

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Christopher L. House

University of Michigan at Ann Arbor - Department of Economics ( email )

611 Tappan Street
Ann Arbor, MI 48109-1220
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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