do firms slash wages during recessions (1)
TRANSCRIPT
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Examining the Connection Between Average Real
Wages and Unemployment During the Great Recession
and RecoveryAditya Devineni & Michael Letts
VCU Econ 431Dr. Stratton
April 17th, 2015
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Background● Despite marked improvements in the labor market,
average real wages have barely risen since the Great Recession.
● ASAD model normally suggests wage stagnation should be interpreted as indicative of an underutilization of available labor resources, since firms bid wages higher during high employment to attract employees.
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Standard Unemployment Rate
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Compensation of Employees: Wage and Salaries
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● Is it possible the believed relationship between nominal wages and unemployment fails during recessions and recoveries, due to firm-behavior not being fully accounted for by the ASAD model . . . ?
● May part of the explanation for wage stagnation be firms are simply struggling to recoup losses from keeping wages intact after such a deep recession . . . ?
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Theory● Sticky Wage Theory
○ Firms rarely slash wages.
○ Why? Primarily because of union contracts, fear of worker discontent and reduced output, and inter-firm politics.
● Pent-Up Wage Deflation○ Without slashing nominal wages, firms must recoup losses from keeping wages
intact over time and, consequently, will not be able to bid wages higher in response to labor market improvements.
● Ricardian Model○ Firm output is proven to be positively correlated with wages; as employee
productivity increases, wages also tend to increase. Firms have an incentive not to cut wages in order to keep output high.
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Hypothesis and Methods● Hypothesis:
○ The correlation between average real wages and unemployment weakens considerably during recessions and throughout recoveries.
● Methods: ○ Data indexed to 2000, adjusted to 2000 dollars, and measured
quarterly.○ Analysis is split into four parts: Quarters 1 through 4, in order to
eliminate seasonal effects and glean closer insight into possible trends.
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LiteratureHornstein, Andreas; Kudlyak, Marianna; and Lange, Fabian. “A New Measure of Resource Utilization in the Labor Market.” Federal Reserve Bank of Richmond. 18 Apr 2014.
Kudlyak, Marianna; Lubik, Thomas; and Rhodes, Karl, “How Should the Fed Interpret Slow Wage Growth?” Economic Brief, No. 15-20. Feb 2015.
Yellen, Janet L., “Labor Market Dynamics and Monetary Policy,” Remarks at the Federal Reserve Bank of Kansas City Economic Symposium in Jackson Hole, Wyoming. 22 Aug 2014.
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Purpose
● Federal mandate of maximum employment means analyzing various labor metrics is imperative to fully understanding actual labor market conditions and subsequent policy decisions.
● Previous assumptions about the relationship between wages and unemployment may obfuscate interpretations of the labor market and lead to misinformed policy decisions.
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Conclusion● ASAD model does not fully account for firm behavior. Consequently,
the model misrepresents actual trends between average real wages and unemployment.
● We predict the relationship between average real wages and unemployment weakens considerably during recessions and throughout recoveries, since firms do not slash wages and must recoup losses.
● Hence, wage stagnation is likely due to pent-up wage deflation; not a gross underutilization of available labor resources, as many economists have portended in the past.