Testing for Downward Rigidity in Nominal Wage Rates: Evidence From Contract Data

Alan Harrison

Abstract

The proposition that nominal wages are rigid downward has recently led some commentators to question the wisdom of central banks' pursuing a policy of low price inflation. The argument is that, at very low rates of inflation, the nominal wage rigidity inhibits the ability of the labour market to effect adequate adjustment through variations in nominal wages, and the inability to adjust in turn leads to unemployment. The question of whether nominal wage rates are indeed downwardly rigid therefore becomes critical.
Canadian evidence drawn from unionized contract data, reported in Fortin (1996), has been cited approvingly in this debate (for example, by Akerlof, Dickens and Perry, 1996), but this evidence looks only at very recent experience and uses only unconditional tests. Other periods of low inflation may have much to say on this subject, and more sophisticated tests are required if we are to distinguish wage settlements that would have been negative in the absence of wage rigidity from those that would anyway have left nominal wages unchanged.
My paper investigates these issues, using Canadian data on unionized wage contracts covering the period from the early 1950s to the present. To provide context for what follows, I look first at unconditional tests for rigidity. I then turn to use of a method that allows me to look for excess mass at a particular point in a distribution of nominal wage changes.
Specifically, I adopt an approach based on work by Donald, Green and Paarsch (1995), that has been used by Green and Paarsch (1996) to examine the effects on the wage distribution of the minimum wage. This approach has several benefits for my work. First, it allows maximum flexibility in the fitted density of wage changes; second, it can accommodate covariates that can affect both the shape and the position of the density; third, the effects of covariates can vary across segments of the distribution.
I estimate the distribution of nominal wage changes, incorporating covariates that include the rate of price inflation and measures of productivity growth. Early results indicate the importance of the latter variable, and suggest (as one might perhaps expect) that it is the combination of low inflation and low productivity that is most likely to generate mass in the distribution of wage changes at the point where the change is zero. The tests also confirm the presence of nominal wage rigidity in unionized contracts, though the magnitude of the phenomenon is much lower than the estimates reported by Fortin (1996).

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