Wage Formation Under Low Inflation

25 Pages Posted: 14 Sep 2004

See all articles by Steinar Holden

Steinar Holden

University of Oslo - Department of Economics; Norges Bank; CESifo (Center for Economic Studies and Ifo Institute)

Date Written: August 2004

Abstract

This paper reviews the literature on the effects of low steady-state inflation on wage formation, focusing on four different effects. First, under low inflation, downward nominal wage rigidity (DNWR) may prevent real wage cuts that would have happened had inflation been higher. Second, wages (and prices) are given in nominal contracts, and inflation affects both how often wages are adjusted, and to what extent wages are set in a forward-looking manner. Third, incomplete labour contracts may provide workers with scope for inflicting costs on the firm without violating the contract, thus forcing the firm to accept a rise in nominal wages. Fourth, if effort depends on wages relative to a reference level, and workers and firms underweight inflation when updating the reference level, positive but moderate inflation may reduce wage pressure. The paper ends by a brief survey of empirical evidence, and a discussion of whether labour markets may adapt to a low inflation environment.

Keywords: wage formation, nominal contracts, inflation

JEL Classification: J5, J3, E31

Suggested Citation

Holden, Steinar, Wage Formation Under Low Inflation (August 2004). Available at SSRN: https://ssrn.com/abstract=590621 or http://dx.doi.org/10.2139/ssrn.590621

Steinar Holden (Contact Author)

University of Oslo - Department of Economics ( email )

P.O. Box 1095 Blindern
N-0317 Oslo
Norway
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+47 22 85 50 35 (Fax)

HOME PAGE: http://folk.uio.no/~sholden/

Norges Bank ( email )

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CESifo (Center for Economic Studies and Ifo Institute)

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Munich, DE-81679
Germany

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