Does Inflation "Grease the Wheels of the Labor Market"?

69 Pages Posted: 19 Jul 2004 Last revised: 21 Aug 2022

See all articles by David Card

David Card

University of California, Berkeley - Department of Economics; Institute for the Study of Labor (IZA); National Bureau of Economic Research (NBER)

Dean Hyslop

Motu Economic and Public Policy Research

Multiple version iconThere are 2 versions of this paper

Date Written: April 1996

Abstract

If nominal wages are downward rigid, moderate levels of inflation may improve labor market efficiency by facilitating real wage cuts. In this paper we attempt to test the hypothesis that downward real wage changes occur more readily in higher-inflation environments. Using individual wage change data from two sources, we find that about 6-10 percent of workers experience nominally rigid wages in a 10- percent inflation environment. This proportion rises to over 15 percent at a 5 percent inflation rate. We use the assumption of symmetry to generate counterfactual distributions of real wage changes in the absence of rigidities. These counterfactual distributions suggest that a 1 percent increase in the inflation rate reduces the fraction of workers with downward-rigid wages by about 0.8 percent, and allows real wages to fall about 0.06 percent faster. A market- level analysis of the effects of nominal rigidities, based on wage growth and unemployment at the state level, is less conclusive. We find only a weak statistical relationship between the rate of inflation and the pace of relative wage adjustments across local labor markets.

Suggested Citation

Card, David E. and Hyslop, Dean R., Does Inflation "Grease the Wheels of the Labor Market"? (April 1996). NBER Working Paper No. w5538, Available at SSRN: https://ssrn.com/abstract=3084

David E. Card (Contact Author)

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Dean R. Hyslop

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