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Monday, July 15, 2013

FRBSF Economic Letter: The Path of Wage Growth and Unemployment

Evidence of nominal wage rigidity:

The Path of Wage Growth and Unemployment, by Mary C. Daly, Bart Hobijn, and Timothy Ni, FRBSF Economic Letter: During the most recent recession the unemployment rate jumped 5.6 percentage points, but wage growth slowed only modestly. The economy has been recovering for four years and unemployment has declined considerably, but wage growth has continued to slow. These patterns contradict standard economic models that hold that unemployment and wage growth normally are tightly related and move in opposite directions.
This Economic Letter argues that these patterns are consistent with the reluctance of employers to adjust wages immediately in reaction to changing economic conditions. In particular, employers hesitate to reduce wages and workers are reluctant to accept wage cuts, even during recessions. This behavior, known as downward nominal wage rigidity, played a role in past recessions, but was especially apparent during the Great Recession. Wage rigidity kept nominal wage growth positive throughout the recession. This led to a significant buildup of pent-up wage cuts, that is, wage cuts that employers wanted, but were unable to make. As the economy recovers, pent-up wage cuts will probably continue to slow wage growth long after the unemployment rate has returned to more normal levels.

Figure 1
Distribution of wage changes in 2006 and 2011

Distribution of wage changes in 2006 and 2011

Source: Current Population Survey and authors’ calculations.
Note: Wage changes are measured as approximate percentage changes.

The existence of downward nominal wage rigidity
Figure 1 clearly shows downward nominal wage rigidity in the distribution of wage changes among U.S. workers in 2006 and 2011. The data cover all workers and measure how their wages compared with their previous year’s wages, if they were employed. We use 2006 as an example of a typical wage change distribution and compare those numbers with the post-recession wage changes for 2011.
The distribution of wage changes in 2006 and 2011 both spike at zero, suggesting that the wages of many workers did not change from year to year. In both years, the distribution is larger to the right of zero, that is, for wage increases, than to the left of zero, for wage cuts. Consistent with downward nominal rigidity, this suggests that a large fraction of wage cuts employers wanted to carry out were not actually made. Instead, those workers were swept into the zero-change group.
What is more interesting in this figure is how 2006 and 2011 data differ. First, the fraction of workers whose wages were frozen jumped from 12% of the workforce in 2006 to 16% in 2011. Second, despite the severity of the Great Recession, very few workers experienced wage cuts. These numbers edged up only slightly from 2006 to 2011. Finally, and perhaps most interestingly, the percentage of workers who received wage increases dropped notably in 2011 compared with 2006. This compression of wage increases resulted in a larger spike at zero. ...

There's quite a bit more in the article, including a discussion of the wage Phillips curve.

    Posted by on Monday, July 15, 2013 at 10:53 AM in Economics, Unemployment | Permalink  Comments (10)


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