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Labor Markets and Inflation:The International Wage
Flexibility Project
Presentation at
National Bank of Belgium Conference on Wage and Price Rigidities in an
Open Economy
13 October, 2006
What is the IWFP?
• 13 Country study of wage inflation Sponsored by the ECB and directed by Erica Groshen (NY Fed.) and me
• using micro data on individual and occupational wages analyzed by teams in each country familiar with the data to be used
• meta-analysis of country level results by team including directors plus Lorenz Goette, Steinar Holden, Julian Messina, Mark E. Schweitzer, Jarkko Turunen, and Melanie E. Ward
• broader than just analyzing wage rigidity (sand and grease), but that is the part that I’m going to talk about today
Where to Find Full Paper
• Results: http://brookings.edu/es/research/projects/iwfp_jep.pdf
• Methodology: http://brookings.edu/es/research/projects/200509_iwfp.pdf
• Or navigate to brookings.edu– then go to list of scholars– then go to my page– then look under current projects for “13 country study
of wage rigidity” and click through to that page– all the papers for this project are linked to that page
Country Teams
• Austria• Belgium• Denmark• Finland• France• Germany• Italy
• Norway• Portugal• Sweden• Switzerland• United Kingdom• United States
Disclaimer!Opinions expressed in this
presentation are mine and mine alone. They should not be attributed to any other individuals in the IWFP, their employers, or associates, nor should
they be attributed to the organizations sponsoring the IWFP.
My Motivation
• Today many central banks have chosen to explicitly target inflation (and the ones that don’t often do it implicitly).
• Many of these targets are very low (2% or less). • In 1996 article with Akerlof and Perry (ADP) we showed
that low inflation in the presence of downward nominal rigidity could lead to substantial unemployment in the long run.
• Is overly low inflation causing considerable unemployment (particularly in Europe where unemployment rates have been stubbornly high)?
• Although ADP model fits well for US and Canada, it fits very poorly for Britain and continental European countries. Is “real rigidity” a confounding problem that makes ADP model inappropriate?
Motivation(Continued)
• Most previous (pre IWFP) studies of European wage rigidity use macro data to determine extent (and concept of rigidity measured is slow adjustment to economic circumstances rather than downward rigidity)
• Early exceptions include Smith (2000) and Nickell and Quintini (2001) who both analyze British micro wage data and find much less evidence of DNWR than in US data
• Biscourp et al. (2004) find mixed results for France• Knoppik and Thomas Beissinger (2003) find substantial
DNWR in Germany• Fehr and Gotte (2004) find substantial DNWR in
Switzerland• Is there really substantial variation across countries or do
differences reflect methodological differences?
How To Measure Rigidity?
• Initially we were unsure about how to get at presence of different types of rigidity.
• I was mainly interested in looking at the extent of DNWR across countries using consistent methodology.
• At first meeting some very interesting results emerged examining wage change histograms.
What We Are Going to See
• Histograms of wage percentage wage changes• We are looking only at job stayers• In some cases we are looking at reported hourly
wages• In other cases a measure of income divided by
hours of work• Some are from surveys, some from social security
data, some from other types of administrative records
0.0
5.1
.15
-15 -10 -5 0 5 10 15 20 25
United States 1987
0.0
5.1
.15
-15 -10 -5 0 5 10 15 20 25
Finland 1988
0.0
5.1
.15
-15 -10 -5 0 5 10 15 20 25
United Kingdom 1984
0.0
5.1
.15
-15 -10 -5 0 5 10 15 20 25
Ireland 1996
Black lines indicate contemporaneous and prior year's inflation rates
Red-Normal, Green-Weibull, Blue Bars-Data, Yellow-Zero Spike
Figure 1: Alternative Wage Change Distributions
Can we use wage change histograms to diagnose the nature
and extent of wage rigidity?
Wage Change Distribution(For workers with same wage facing same minimum wage)
-0.22
-0.19
-0.16
-0.13
-0.10
-0.07
-0.04
-0.01
0.02
0.05
0.08
0.11
0.14
0.17
0.20
0.23
0.26
Change in Log Wage
Freq
uenc
y
No Nominal Wage Change
No Real Wage Change
Observatuions Swept Down to Zero by
Menu Costs
Observations Swept Up to Rate of Price Inflation By Downward Real
Wage Rigidity
Observations Swept Up to Zero By Downward Nominal Wage Rigidity
and Menu Costs
Big Problem is Measurement Error
• If people make mistakes reporting their wages then we see wage changes where there are none.
• If we compute wage=income/hours we see “wage” changes due to overtime, bonuses, or mistakes in reporting hours.
• If we use SS data we have similar problems since almost no country has data that allow us to accurately identify base wage.
• All evidence suggests that for most data sets frequency and extent of errors make this a very serious problem (evidence suggests that in many data sets most reported wage cuts are actually errors of these sorts).
Correcting for ErrorsUse information in correlation between years
• Abowd and Card (1989) suggest that wages have two components:
– permanent changes
– transient (one period) changes (which result in negative serial correlation of wage changes)
• New method identifies transient changes as errors and uses auto-covariance and frequency of sign switching in changes to identify error rate and error variance.
• This information is used to identify semi-non-parametric estimate of true wage distribution (that is we estimate the histogram of wage changes we would see if there were no
errors).
How Do We Know Frequency and Severity of Errors?
• First crucial assumption is that errors are only important source of covariance in wage changes from one year to next.
• With that assumption we can identify the frequency of errors, and the variance of those errors when they are made, by looking at the auto-covariance of wage changes and the number of people who have sequential large wage changes of opposite signs.
• We estimate a statistical model of the wage change distribution and the error process using method of moments.
Validating Primary Assumption
• Results applying new method to US largely fit with those of other studies (a very high degree or downward nominal rigidity).
• Finnish and German data has virtually no errors and estimated covariances are tiny and sometimes positive.
• Portuguese have good and bad data and (as we will see) the correction doesn’t change the good data, but makes the bad data look like the good data.
Portugese DataBase wage+other labor earnings -1994
-0.02
0
0.02
0.04
0.06
0.08
0.1
0.12
-25 -23 -21 -19 -17 -15 -13 -11 -9 -7 -5 -3 -1 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49
Base wage - 1994
-0.02
0
0.02
0.04
0.06
0.08
0.1
0.12
-25 -23 -21 -19 -17 -15 -13 -11 -9 -7 -5 -3 -1 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49
Base wage+other labor earnings-1992
-0.01
0.01
0.03
0.05
0.07
0.09
0.11
0.13
0.15
-25 -22 -19 -16 -13 -10 -7 -4 -1 2 5 8 11 14 17 20 23 26 29 32 35 38 41 44 47 50
Base wage-1992
-0.01
0.01
0.03
0.05
0.07
0.09
0.11
0.13
0.15
-25 -22 -19 -16 -13 -10 -7 -4 -1 2 5 8 11 14 17 20 23 26 29 32 35 38 41 44 47 50
More ValidationAnalysis of Gottschalk Data
• Gottschalk uses regression discontinuity analysis of individual micro data to discriminate between true wage changes and errors in SIPP quarterly data (finds almost no negative wage changes) .
• We analyzed his data and found that all auto-covariance in wage changes due to errors (validating our identifying assumption).
Three Ways to Estimate Three Types of Rigidity
• Problem is to generate counterfactual distribution (or notional wage change distribution) with which to compare actual wage change distribution.
• Three possibilities– Assume an ideal form for the notional distribution
– Assume that the notional distribution is symmetric
– Assume that the notional distribution has constant shape over time
We use the ideal form method (2-sided Weibull)
Figure 6 2-Sided Weibull vs. Actual for US 97
00.020.040.060.080.1
0.120.140.160.18
Percentage Wage Change
Fre
qu
en
cy
Actual Weibull
Figure 7 2-Sided Weibull vs. Actual for UK 1988
0
0.02
0.04
0.06
0.08
0.1-0
.20
-0.1
7
-0.1
4
-0.1
1
-0.0
8
-0.0
5
-0.0
2
0.00
0.04
0.07
0.10
0.13
0.16
0.19
0.22
0.25
0.28
Percentage Wage Change
Freq
uen
cy
Actual Weibull
Ideal Distribution(only method I’m going to discuss today)
• In general, two-sided Weibull fits upper tail of nearly all distributions very well and Gottshalk’s true wage changes (upper tail) have two-sided Weibull shape.
• So we will assume that notional wage change distribution is 2-sided Weibull and estimate its parameters along with– A fraction r of workers are subject to downward real wage
rigidity and if their notional wage change < expected inflation they get expected inflation
– A fraction n of workers are subject to downward nominal wage rigidity and if their notional wage change <0 they get wage freeze.
– A fraction of workers are subject to symmetric nominal rigidity and get no wage change if their notional wage change is within 2% of zero on either side
Aside: What Sort of Process Gives Rise to Weibull?
• Wage increases (above some average level) result from tournament with winners at each level getting an increase of a fixed size and then competing only with winners of first round for a larger increase in next round.
• Size of increase from winning a round grows exponentially.
• This is notably different from normal distribution that would result if workers were evaluated on many independent criteria and then given raises depending on how many they satisfied.
0.2
.4.6
.8Real and Nominal Ridigity by Country
Real Rigidity Nominal Rigidity
International Comparisons• Considerable variation across countries in the extent of
downward nominal and downward real wage rigidity despite correction for differences in data quality
• Some tendency for countries to have either DNWR or DRWR but not both (tendency is stronger when we restrict comparison to the 90s)
• How do our estimates compare to those of others and between different data sources in our own sample? – ECHP results with other data sets correlate .53 for both real and
nominal rigidity– Wouldn’t expect perfect correlation since time periods don’t
overlap and we do see some changes over time– Country averages for nominal rigidity correlate .55 with simple
measures constructed from uncorrected data– Country averages for real rigidity correlate .25 with simple
measure used in JEP paper constructed from uncorrected data
Austria Denmark
Finland
France
Germany
ItalyPortugal
UK
.1.2
.3.4
.5.6
Cou
ntry
Est
imat
es.
19
90s
0 .2 .4 .6 .8ECHP Estimates
Comparing DNWR from different datasets
AustriaBelgium
Denmark
Finland
FranceGermany
Greece
Ireland
Italy
Portugal
UK
0.2
.4.6
.81
KB
DN
WR
0 .2 .4 .6 .8IWFP n ECHP only
Knoppik and Beissinger r=.74(.09)
Austria
Belgium
Denmark
Finland France
Germany
Greece
Ireland
Italy
Netherlands
Norway
Portugal
Sweden
Switzerland
UK
0.2
.4.6
.81
HW
DN
WR
0 .2 .4 .6 .8IWFP n
Holden and Wulfsberg r=.45(.08)
Source: HW (2005) FWCP from Table B1, page 38; KB (2005) Table 4, page 29 and IWFP.
What is Correlated with Downward Nominal Rigidity?
UK
SE
PT
NO
IT
IE
DE
US
GR
FR
FI
SZ
DK
BE
AT
NL
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1.0
0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0
Aggregate EPL
n
UK
SE
PT
NO
IT
IE
DE
US
GR
FR
FI
SZ
DK
BE
AT
NL
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1.0
0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5
Corporatism
n
UK
SE
PT
NO
IT
IE
DE
US
GR
FR
FI
SZ
DK
BE
AT
NL
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1.0
0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9
Union Density
n
NL
AT
BE
DK
SZ
FI
FR
GR
US
DE
IE
IT
NO
PT
SE
UK
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1.0
0.0 0.2 0.4 0.6 0.8 1.0 1.2
Wage Indexation
n
NL
AT
BE
DK
SZ
FI
FR
GR
US
DE
IE
IT
NO
PT
SE
UK
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1.0
0.0 20.0 40.0 60.0 80.0 100.0
Bargaining Coverage
n
UK
SE
PT
NO
IT
IE
DE
US
GR
FR
FI
SZ
DK
BE
AT
NL
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1.0
0.0 10.0 20.0 30.0 40.0 50.0 60.0 70.0
Minimum Wage / Average Wage
n
What is Correlated with Downward Real Wage Rigidity?
UK
SE
PT
NO
IT
IE
DE
USGR
FR
FI
SZ
DK
BE
AT
NL0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0
Aggregate EPL
r
UK
SE
PT
NO
IT
IE
DE
US
GR
FR
FI
SZ
DK
BE
AT
NL0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5
Corporatism
r
UK
SE
PT
NO
IT
IE
DE
US
GR
FRFI
SZ
DK
BE
AT
NL0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9
Union Density
r
NL
AT
BE
DK
SZ
FIFR
GRUS
DE
IE
IT
NO
PT
SE
UK
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.0 0.2 0.4 0.6 0.8 1.0 1.2
Wage Indexation
r
NL
AT
BE
DK
SZ
FI
FR
GRUS
DE
IE
IT
NO
PT
SE
UK
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.0 20.0 40.0 60.0 80.0 100.0
Bargaining Coverage
r
UK
SE
PT
NO
IT
IE
DE
USGR
FRFI
SZ
DK
BE
AT
NL
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.0 10.0 20.0 30.0 40.0 50.0 60.0 70.0
Minimum Wage / Average Wage
r
What is Correlated with Rigidity?
• Nothing consistently statistically significant at conventional levels.
• Union membership and bargaining coverage variables statistically significant at .1 level (we are getting better results now using time series variation).
• Notable case is US where real rigidity was notable in 1970s but disappears in the 1980s after the breakdown of pattern bargaining.
Does Rigidity Affect Unemployment?
• According to Akerlof, Dickens and Perry 1996 a 1 percent increase in in nominal wages due to rigidity should create somewhere between a 1 and 5 percentage point increase in unemployment
• We compute estimates of the impact of each type of rigidity on wages and estimate a series of models of the impact of rigidity.
Table 3Effects of Rigidity on Unemployment
Dependent Variable/Specification
Unemployment Change in Inflation(Phillips Curve)
Unemployment Effect (b/a)
1.26 .90 2.99 2.90
Standard Error (.35) (.32) (1.28) (2.09)
p for null hypothesis 0 b/a
(one tail test)
.00 .01 .01 .08
Controls for year(all contain controls for
dataset (country))
no yes no yes
Conclusions on Unemployment
• Unemployment effects generally statistically significant.
• Can’t reject the hypothesis that unemployment effects are in the range predicted by ADP model.
• Can’t reject the hypothesis that effects of real and nominal rigidity are equal (as theory predicts).
(Tentative) Policy Implications
• Most Euro-zone countries characterized by downward real wage rigidity rather than downward nominal wage rigidity. Benefits of increased inflation may not be so great in those countries compared to US and Canada (recent nominal wage cuts in Germany are example of how corporatist countries can overcome nominal wage rigidity).
• Several Euro-zone countries have substantial downward nominal wage rigidity so allowing inflation to move to bottom end of ECB target zone could be very costly. Should this happen these countries might be better off if they left EMU. Though gains would be minor given ECB policy to date.
More Policy Conclusions• No evident effect of EMU on rigidity in these
data (though most data don’t go back far enough to tell if there are effects of Maastricht treaty).
• No Evidence that persistent low inflation reduces the incidence of downward nominal wage rigidity. Thus no evidence that institutions adapt to low inflation.
• For US new method confirms results of previous studies – significant DNWR. New finding is that there is no evidence of DRWR by 1990s. Thus Fed should avoid very low inflation.
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