Does Contractual Wage Rigidity Play a Role in Determining Real Activity?

Abstract

Interest in nominal wage ridigity as a source of macroeconomic fluctuations has waxed and waned over the past half-century. The most recent wave of interest was triggered by the rational expectations revolution of the 1970s, which inspired an improved sticky-wage paradigm. The paradigm posits the existence of short-term contractual arrangements that, in their simplest form, fix wage schedules in nominal terms for a predetermined period (the life of the contract) and leave employment at the discretion of the firm. The most influential examples of the paradigm incorporate rational expectations and satisfy the natural-rate hypothesis [9; 14], thus meeting the new minimum standards for demand-driven theories of the business cycle. Nominal wage contracting models have been vigorously criticized for both a lack of theoretical rigor and an absence of empirical support. Despite their critics, however, the models have remained a popular analytical tool and, after almost a decade of inattention, economists are showing a renewed interest in empirical tests of nominal contracting models.' The studies produced to date are small in number and offer conflicting conclusions. They are, perhaps, as important for the objections they provoke as for the answers they provide.' While the work reported in this paper

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