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.

According to standard economic models, adverse demand shocks will lead to bigger
employment losses if institutional factors like minimum wages and trade unions prevent real
wages from falling. Some economists have argued that this insight explains the contrast
between the United States, where real wages fell over the 1980s and aggregate employment
expanded vigorously, and Europe, where real wages held steady and employment was
stagnant. We test the hypothesis by comparing recent changes in wages and employment
rates for different age and education groups in the United States, Canada, and France. We
argue that the same forces that led to falling real wages for less-skilled workers in the U.S.
also affected Canada and France. Consistent with the view that labor market institutions in
Canada and France reduce wage flexibility, we find that the relative wages of less-skilled
workers fell more slowly in Canada than the U.S. during the 1980s, and did not fall at all in
France. Contrary to expectations, however, we find little evidence that wage inflexibilities
generated divergent patterns of relative employment growth across the three countries.