Does Inflation 'Grease the Wheels of the Labor Market'?

Abstract

One of the basic tenets of Keynesian economics is that labor market institutions cause downward nominal wage rigidity. We attempt to evaluate the evidence that relative wage adjustments occur more quickly in higher-inflation environments. Using matched individual wage data from consecutive years, we find that about 6-10 percent of workers experience wage rigidity in a 10-percent inflation environment, while this proportion rises to over 15 percent when inflation is less than 5 percent. By invoking a simple symmetry assumption, we generate counterfactual distributions of wage changes from the distributions of actual wage changes. Using these counterfactual distributions, we estimate that, over the sample period, a 1 percent increase in the inflation rate reduces the fraction of workers affected by downward nominal rigidities by about 0.5 percent, and slows the rate of real wage growth by about 0.06 percent. Using state-level data, the analysis of the effects of nominal rigidities is less conclusive. We find only a weak statistical relationship between the rate of inflation and the pace of relative wage adjustments across local labor markets.