Wage Dynamics: Reconciling Theory and Evidence

Olivier Blanchard and Lawrence Katz

No 6924, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: U.S. macroeconomic evidence shows a negative relation between the rate of change of wages and unemployment. In contrast, most theories of wage determination imply a negative relation between the level of wages and unemployment. In this paper, we ask whether one can reconcile the empirical evidence with theoretical wage relations. We reach three main conclusions. First, we derive the condition under which the two can indeed be reconciled. We show the constraints that such a condition imposes on the determinants of workers' reservation wages as well as the relative importance of workers' outside options as opposed to match specific productivity in wage determination. Second, in the light of this condition, we reinterpret the presence of an "error correction" term in macroeconomic wage relations for most European economies but not in the United States. Third, we show that whether this condition holds or not has important implications for the effects of a number of variables -- from real interest rates to oil prices to payroll taxes -- on the natural rate of unemployment.

JEL-codes: E31 J64 (search for similar items in EconPapers)
Date: 1999-02
New Economics Papers: this item is included in nep-pke
Note: LS
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (319)

Published as American Economic Review, Vol. 89 (May 1999): 69-74.

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