The Wage Inflation‐Unemployment Curve at the Macroeconomic Level
| Author | Sophie Saglio,Antonia López‐Villavicencio |
| Date | 01 February 2017 |
| Published date | 01 February 2017 |
| DOI | http://doi.org/10.1111/obes.12139 |
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©2016 The Department of Economics, University of Oxford and JohnWiley & Sons Ltd.
OXFORD BULLETIN OF ECONOMICSAND STATISTICS, 79, 1 (2017) 0305–9049
doi: 10.1111/obes.12139
The Wage Inflation-Unemployment Curve at the
Macroeconomic Level
Antonia L ´
opez-Villavicencio† and Sophie Saglio‡
†GATE-CNRS, University Lyon 2, 93, chemin des Mouilles B.P.167, 69131 ECULLY cedex,
France (e-mail: lopez@gate.cnrs.fr)
‡LED, University of Paris 8, 2 rue de la Libert´e, 93526 SAINT-DENIS, France
(e-mail: s.saglio@univ-paris8.fr)
Abstract
Based on the reduced form New Keynesian Wage Phillips Cur ve, we estimate wage rigid-
ity and indexation at the aggregate level in several advanced countries for the 1985–2014
period. We document that the wage setting process is heterogenous among our sample of
countries: nominal wage rigidities are more important in the United States, while wage
indexation is dominant in European Countries. We also present evidence that indexation to
past inflation has decrease as inflation stabilizes at lowerlevels. In addition, our results sug-
gest that wage rigidity is not linked to the institutional environment at the macroeconomic
level. Finally, we show that there is significant time variation in the estimated coefficients
on the implied equation that is usually not taken into account in the theoretical literature.
I. Introduction
The most popular approach to capture the way in which unemployment and other real
disturbances affect wages is the ubiquitous Phillips Curve. This empirical and macro-
economic proposition suggests a stable relationship between unemployment and nominal
wage growth, with higher unemployment restraining wage changes. However, the original
relationship and the empirical applications that followed are usually criticized for lacking
any microeconomic theoretical foundation, except the principle that ‘when demand for
labour is high and there are very few unemployed we should expect employers to bid wage
rates up quite rapidly’ (Phillips, 1958).
Recently, this debate has been revisited with Gali (2011) and Gali, Smets and Wouters
(2011) providing plausible theoretical foundations to the dynamic relation between wage
inflation and unemployment. Indeed, by reformulating the New Keynesian (NK) wage
equation, Gali (2011) introduces unemployment to an otherwise standard NK model with
staggered wage setting. Their reformulation has the advantage of the observability of the
associated driving force (i.e. the unemployment rate), which contrasts with the inability
to observe of the wage markup or the output gap, which are the driving forces in typical
JEL Classification numbers: C32, E24, J30
56 Bulletin
NK models. Under some assumptions, their proposed relation takes a form similar to the
empirical applications of the Phillips curve. Nonetheless, contrary to the purely empirical
proposition, the so-called New Keynesian Wage Phillips Curve (NKWPC) is a micro-
founded structural relation between wage inflation and unemployment, with coefficients
that are functions of parameters that have a structural interpretation. In particular, the slope
of the curve is decreasing in the degree of wage rigidity. In the limit, when wage rigidity
approaches zero, i.e. the case of full flexibility, the curve becomes vertical (Gali, 2011).
Based on this framework, we add to the literature by providing estimates of the slope
of the implied wage inflation-unemployment curve for severaladvanced countries over the
1985q1–2014q3 period. We also examine the degree of wage indexationto past inflation for
our sample of countries. Moreover, our study contributes to the understanding of the nature
of the wage rigidities and indexation in different macroeconomic and policy environment.
In particular, we allow the degree of wage indexation and rigidity to vary according to
(i) the inflation environment and/or (ii) labour market institutions. In the first case, it is
believed that disinflation has limited wage indexation, even though it is not clear how it
affects nominal wage rigidity. In the second case, the institutional setting is supposed to
affect both the resistance to nominal wage cuts and the evolution of wage indexation.
The empirical literature on wage rigidity and indexation at a macroeconomic level
is very scarce. On the one hand, most of the contributions are based on individual and
firm level data.1This rich literature provides a host of new results about nominal wage
rigidities at a microeconomic level. However, micro studies derive wage rigidity from
wage changes of individuals engaged in ongoing employment relationships. Moreover,
wage rigidity for job stayers may not translate into similar levels of rigidity at higher levels
of aggregation. On the other hand, the few macroeconomic studies concentrate either on
price indexation or resistance to nominal wage cuts for single countries or in a panel data
setting.2By doing so, changes and differences in wage rigidities across countries are not
observed, even though the characteristics of the wage setting process may vary markedly
among countries. Measuring wage rigidity at the macroeconomic level is thus particularly
relevant.
In this paper, we fill these gaps in the literature by providing country-by-country mea-
sures of wage rigidity and price indexation at the macroeconomic level.Under this scenario,
our results allow us to make country comparisons and therefore to outline cross-country
heterogeneity.These are important contributions, given the importance of both wage rigid-
ity and indexation, not only for the validity of several theoretical models but also given
their perceived role as factors of macroeconomic stability.
Our results point to substantial differences in the nature of wage rigidities in our sample
of countries. In particular, we detect countries with high and low wage rigidity at the
aggregate level as well as different degrees of wage indexation. We also evidence that
the inflation wage-unemployment relationship have exhibited profound shifts during our
sample period. Indeed, our analysis reveals that indexation weakened as disinflation took
place even though this process has not been accompanied by more resistance to nominal
1See Altonji and Devereux (1999), Dickens et al. (2007), Holden and Wulfsberg (2008, 2009), Messina et al.
(2010) or Barattieri, Basu and Gottschalk (2014).
2See Gali (2013), Muto and Shintani (2014) and Schryder, Peersman and Wauters(2014).
©2016 The Department of Economics, University of Oxford and JohnWiley & Sons Ltd
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