Downward nominal wage rigidity in Canada: Evidence against a greasing effect

Joel Wagner ()

Canadian Journal of Economics, 2018, vol. 51, issue 3, 1003-1028

Abstract: The existence of downward nominal wage rigidity (DNWR) has often been used to justify a positive inflation target. It is traditionally assumed that positive inflation could grease the wheels of the labour market by putting downward pressure on real wages, easing labour market adjustments during a recession. A rise in the inflation target would attenuate the long-run level of unemployment and hasten economic recovery after an adverse shock. Following Daly and Hobijn (2014), we re-examine these issues in a model that accounts for precautionary motives in wage-setting behaviour. We confirm that DNWR generates a long-run negative relationship between inflation and unemployment, in line with previous contributions to the literature. However, we also find that the increase in the number of people bound by DNWR following a negative demand shock rises with the inflation target, offsetting the beneficial effects a higher inflation target has on closing the unemployment gap. As an implication, contrary to previous contributions that neglected precautionary behaviour, the speed at which unemployment returns back to pre-crisis levels during recessions is relatively unaffected by variations in the inflation target.

JEL-codes: E24 (search for similar items in EconPapers)
Date: 2018
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Citations: View citations in EconPapers (1)

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Working Paper: Downward Nominal Wage Rigidity in Canada: Evidence Against a “Greasing Effect” (2017)
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