Do Cost-of-Living Shocks Pass Through to Wages?

102 Pages Posted: 26 Mar 2024 Last revised: 29 Apr 2024

See all articles by Justin Bloesch

Justin Bloesch

Cornell University - Department of Economics; Cornell University - School of Industrial and Labor Relations

Seung Joo Lee

University of Oxford, Saïd Business School

Jacob Weber

Federal Reserve Banks - Federal Reserve Bank of New York

Date Written: February 21, 2024

Abstract

We develop a tractable New Keynesian model where firms post wages and workers search on the job, motivated by microeconomic evidence on wage setting. Because firms set wages to avoid costly turnover, the rate that workers quit their jobs features prominently in the model’s wage Phillips curve, matching U.S. evidence that wage growth tightly correlates with workers’ quit rate. We then examine the response of wages to cost-of-living shocks, i.e., shocks that raise the price of household’s consumption goods but do not affect the marginal product of labor. Such shocks pass through to wages only to the extent that higher cost of living improves worker’s outside options, such as competing jobs or unemployment, relative to their current job. However, higher cost of living lowers real wages at all jobs evenly, and unemployment is rarely a credible outside option. Cost-of-living shocks thus have little to no effect on relative outside options and therefore wages. We conclude that wage posting and on-the-job search, which are prevalent in labor markets such as the United States, limit the scope for pass through from prices to wages and elevate voluntary quits as the primary predictor of nominal wage growth.

Keywords: Monopsony, Inflation, Cost-of-living shocks, On-the-job search

JEL Classification: E31, E52

Suggested Citation

Bloesch, Justin and Lee, Seung Joo and Weber, Jacob, Do Cost-of-Living Shocks Pass Through to Wages? (February 21, 2024). Available at SSRN: https://ssrn.com/abstract=4734451 or http://dx.doi.org/10.2139/ssrn.4734451

Justin Bloesch (Contact Author)

Cornell University - Department of Economics ( email )

414 Uris Hall
Ithaca, NY 14853-7601
United States

Cornell University - School of Industrial and Labor Relations ( email )

Ithaca, NY 14853-3901
United States

Seung Joo Lee

University of Oxford, Saïd Business School ( email )

Park End Street
Oxford, OX1 1HP
United Kingdom

HOME PAGE: http://seungecon.github.io

Jacob Weber

Federal Reserve Banks - Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

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