RDP 2000-08: Nominal Wage Rigidity in Australia 1. Introduction

The assumption that prices and wages in an economy are sticky has a long tradition in economics and has been central to the development of many macroeconomic debates. Foremost, it implies that nominal shocks, such as changes in monetary policy, can have real economic effects. In recent years, the existence of sticky prices and wages has been used to argue against the adoption of a zero inflation target (Akerlof, Dickens and Perry 1996). This is because, in the presence of such nominal rigidities, a small positive rate of inflation can facilitate the real relative price and wage adjustments necessary for the efficient allocation of resources; but if inflation is zero (or very low), these adjustments may not be adequate.

It is also usually assumed that prices and wages tend to be less flexible downward than upward (Tobin 1972). There has been considerable investigation of the nature and extent of price flexibility, and the results support this type of asymmetry to varying degrees.^[1] Much less work, however, has been done on wage flexibility. Rather than appeal to empirical evidence, it has been traditional to simply assume that wages are rigid downwards due to social conventions and notions of fairness (Kahneman, Knetsch and Thaler 1986).

In recent years, though, interest in the actual degree of wage flexibility has increased, sparked by questions about the rationale for observed nominal rigidities and whether their effects are exacerbated by low inflation (Kahn 1997). In particular, it has rekindled interest in whether the long-run Phillips curve is non-vertical because, when inflation is very low, downward nominal wage rigidity inhibits the adjustment of real wages to shocks and causes unemployment to rise (Akerlof et al 1996).^[2]

The purpose of this paper is to identify the nature and extent of downward nominal wage rigidity in Australia, observe how this has changed during the transition to a low-inflation environment and assess its implications for the real economy.

The paper is organised as follows. First, it discusses why downward wage rigidity is likely and how explanations for such behaviour have evolved from simple notions of fairness to become more rationally based. Second, it explores some of the measurement issues involved in the choice of wage data and demonstrates the desirable properties of a panel of occupational wage data from Mercer Cullen Egan Dell that spans periods of high and low inflation in Australia. Third, it presents evidence on skewness away from wage cuts. Finally, the pervasiveness of nominal wage rigidity is assessed.

Footnotes

See Golob (1993), Balke and Wynne (1996), Roger (1995) and Kearns (1998). However, Kearns (1998) finds that the degree of stickiness in Australian consumer prices is relatively low. Furthermore, others have shown that asymmetric price stickiness in Australia may not represent an aversion to price falls but could be explained as the optimising response of firms to their microeconomic environment and the types of shocks they face (De Abreu Lourenco and Gruen 1995). [1]

These inquiries have evolved from an earlier theoretical literature that sought to demonstrate how, following a shock to nominal demand, small nominal frictions can significantly amplify the business cycle. See, for example, Akerlof and Yellen (1985). [2]