Identifying Inflation's Grease and Sand Effects in the Labor Market

51 Pages Posted: 9 Nov 2006 Last revised: 19 Nov 2007

See all articles by Erica L. Groshen

Erica L. Groshen

Federal Reserve Bank of New York; IZA Institute of Labor Economics

Mark Schweitzer

Federal Reserve Banks - Federal Reserve Bank of Cleveland

Multiple version iconThere are 2 versions of this paper

Date Written: October 1997

Abstract

Inflation has been accused of causing distortionary prices and wage fluctuations (sand) as well as lauded for facilitating adjustments to shocks when wages are rigid downwards (grease). This paper investigates whether these two effects can be distinguished from each other in a labor market by the following identification strategy: inflation-induced deviations among employer's mean wage-changes represent unintended intramarket distortions (sand), while inflation-induced, inter-occupational wage-changes reflect intended alignments with intermarket forces (grease).

Using a unique 40-year panel of wage changes made by large mid-western employers, we find a wide variety of evidence to support the identification strategy. We also find some indications that occupational wages in large firms gained flexibility in the past four years. These results strongly support other findings that grease and sand effects exist, but also suggest that they offset each other in a welfare sense and in unemployment effects. Thus, at levels up to five percent, the net impact of inflation is beneficial but statistically indistinguishable from zero. It turns detrimental after that. When positive, net benefits never exceed a tenth of gross benefits.

JEL Classification: C23, E31, J31

Suggested Citation

Groshen, Erica L. and Schweitzer, Mark, Identifying Inflation's Grease and Sand Effects in the Labor Market (October 1997). FRB of New York Staff Report No. 31, FRB of Cleveland Working Paper No. 97-05, Available at SSRN: https://ssrn.com/abstract=943502 or http://dx.doi.org/10.2139/ssrn.943502

Erica L. Groshen (Contact Author)

Federal Reserve Bank of New York ( email )

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HOME PAGE: http://www.newyorkfed.org/research/economists/groshen/index.html

IZA Institute of Labor Economics

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Mark Schweitzer

Federal Reserve Banks - Federal Reserve Bank of Cleveland ( email )

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United States

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