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


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.

Year of Publication
Date Published
Publication Language
Citation Key
In Christina D. Romer and David H. Romer (eds.), Reducing Inflation: Motivation and Strategy, University of Chicago Press, 1997
Working Papers