Nominal and real wage rigidities. In theory and in Europe

• Published in: Journal of macroeconomics 2013-06, Vol.36, p.89-105
• Main Author: Knell, Markus
• Format: Article
• Language: English
• Subjects: DSGE models; Economic conditions; Economic models; Europe; Inflation persistence; Macroeconomics; Modelling; Nominal scales; Nominal wage rigidity; Real wage rigidity; Real wages; Staggered contracts; Structuralism; Studies; Wage determination; Wage rigidity; Western Europe
• ISSN: 0164-0704; 1873-152X
• DOI: 10.1016/j.jmacro.2013.01.006

► Studies the relation between real wage rigidity (RWR) and nominal price and wage rigidity. ► Shows that the two nominal rigidities are the main determinants of RWR. ► Also solves the model with heterogeneous contract length, clustering of contracts and indexation. ► Shows that in order to explain the cross-country variation in RWR one has to take institutional characteristics of wage-setting into account. In this paper I study the relation between real wage rigidity (RWR) and nominal price and wage rigidity. I show that in a standard DSGE model RWR is mainly affected by the interaction of the two nominal rigidities and not by other structural parameters. The degree of RWR is, however, considerably influenced by the modelling assumption about the structure of wage contracts (Calvo vs. Taylor) and about other institutional characteristics of wage-setting (clustering of contracts, heterogeneous contract length, indexation). I use survey evidence on price- and wage-setting for 15 European countries to calculate the degrees of RWR implied by the theoretical model. The average level of RWR is broadly in line with empirical estimates based on macroeconomic data. In order to be able to also match the observed cross-country variation in RWR it is, however, essential to move beyond the country-specific durations of price and wages and to take more institutional details into account.