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Wage Dynamics: Reconciling Theory and Evidence

Author

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  • Lawrence F. Katz
  • Olivier Blanchard
Abstract
U.S. macroeconomic evidence shows a negative relation between the rate of change of wages and unemployment. In contrast, most theories of wage determination imply a negative relation between the level of wages and unemployment. In this paper, we ask whether one can reconcile the empirical evidence with theoretical wage relations. We reach three main conclusions. First, we derive the condition under which the two can indeed be reconciled. We show the constraints that such a condition imposes on the determinants of workers' reservation wages as well as the relative importance of workers' outside options as opposed to match specific productivity in wage determination. Second, in the light of this condition, we reinterpret the presence of an "error correction" term in macroeconomic wage relations for most European economies but not in the United States. Third, we show that whether this condition holds or not has important implications for the effects of a number of variables -- from real interest rates to oil prices to payroll taxes -- on the natural rate of unemployment.
(This abstract was borrowed from another version of this item.)

Suggested Citation

  • Lawrence F. Katz & Olivier Blanchard, 1999. "Wage Dynamics: Reconciling Theory and Evidence," American Economic Review, American Economic Association, vol. 89(2), pages 69-74, May.
    • Handle: RePEc:aea:aecrev:v:89:y:1999:i:2:p:69-74
    Note: DOI: 10.1257/aer.89.2.69
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    File URL: http://www.aeaweb.org/articles.php?doi=10.1257/aer.89.2.69
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    References listed on IDEAS

    as
    1. Abowd, John M. & Kramarz, Francis & Margolis, David N. & Troske, Kenneth R., 2001. "The Relative Importance of Employer and Employee Effects on Compensation: A Comparison of France and the United States," Journal of the Japanese and International Economies, Elsevier, vol. 15(4), pages 419-436, December.
    2. David Card & Dean Hyslop, 1997. "Does Inflation "Grease the Wheels of the Labor Market"?," NBER Chapters, in: Reducing Inflation: Motivation and Strategy, pages 71-122, National Bureau of Economic Research, Inc.
    3. Mortensen, Dale & Pissarides, Christopher, 2011. "Job Creation and Job Destruction in the Theory of Unemployment," Ekonomicheskaya Politika / Economic Policy, Russian Presidential Academy of National Economy and Public Administration, vol. 1, pages 1-19.
    4. David G. Blanchflower & Andrew J. Oswald, 1995. "The Wage Curve," MIT Press Books, The MIT Press, edition 1, volume 1, number 026202375x, April.
    5. Jeff Fuhrer & George Moore, 1995. "Inflation Persistence," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 110(1), pages 127-159.
    6. Fuhrer, Jeffrey C., 2010. "Inflation Persistence," Handbook of Monetary Economics, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 9, pages 423-486, Elsevier.
    7. Karl Whelan, 1997. "Wage Curve vs. Phillips Curve : are there macroeconomic implications?," Open Access publications 10197/246, School of Economics, University College Dublin.
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    More about this item

    JEL classification:

    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity

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