Evaluating the economic significance of downward nominal wage rigidity

Michael Elsby

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: This paper seeks to contribute to the literature on downward nominal wage rigidity (DNWR) along two dimensions. First, we formulate and solve an explicit model of wage-setting in the presence of worker resistance to nominal wage cuts - something that has previously been considered intractable. In particular, we show that this resistance renders wage increases (partially) irreversible. Second, using this model, we can explain why previous estimates of the macroeconomic effects of DNWR have been so weak despite remarkably robust microeconomic evidence. In particular, we show that previous studies have neglected the possibility that DNWR can lead to a compression of wage increases as well as decreases. Thus, the literature may have been overstating the costs of DNWR to firms. Using micro-data for the US and Great Britain, we find robust evidence in support of the predictions of the model. In the light of this evidence, we conclude that increased wage pressure due to DNWR may not be as large as previously envisaged, but that the data is nevertheless consistent with a model in which workers resist nominal wage cuts.

Keywords: Nominal Wage Rigidity; Loss Aversion; Irreversibility (search for similar items in EconPapers)
JEL-codes: E24 E31 J30 J41 (search for similar items in EconPapers)
Pages: 59 pages
Date: 2005-08
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

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http://eprints.lse.ac.uk/19882/ Open access version. (application/pdf)

Related works:
Journal Article: Evaluating the economic significance of downward nominal wage rigidity (2009)
Working Paper: Evaluating the Economic Significance of Downward Nominal Wage Rigidity (2006)
Working Paper: Evaluating the Economic Significance of Downward Nominal Wage Rigidity (2005)
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Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:19882

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