Cyclical Movements in Hours and Effort under Sticky Wages

We examine the response of a sticky-wage economy to various real and nominal shocks. In addition to variations in hours, we allow for an endogenous response in worker effort per hour. Despite wages being predetermined, the labor market clears through the effort margin. We find that the ability of a sticky-wage model to mimic U.S. business cycles is much improved by allowing for reasonable effort movements. The model also provides a ready explanation for the finding that TFP is negatively affected by nominal shocks.Sticky Wages, Endogenous Effort, Productivity, Business Cycles

Welfare Costs of Sticky Wages When Effort Can Respond

We examine the impact of wage stickiness when employment has an effort as well as hours dimension. Despite wages being predetermined, the labor market clears through the effort margin. Consequently, welfare costs of wage stickiness are potentially much, much smaller.Sticky Wage, Endogenous Effort, Welfare Cost

Understanding How Price Responds to Costs and Production

The importance of sticky prices in business cycle fluctuations has been debated for many years. But we argue, based on a large empirical literature from the 1950's and 60's, that it is necessary to distinguish the response of price to an increase in factor prices from its response to an increase in marginal cost generated by an expansion in production. Consistent with that earlier literature, we find for 450 U.S. manufacturing industries that prices do respond more to increases in costs driven by changes in factor prices than to increases in marginal cost precipitated by expansions in output. We explore two models that can potentially explain these findings. Both break the link between price and marginal cost, thereby generating what one might naively interpret as average-cost pricing. The first is driven by firms pricing to limit entry. The second is driven by firms pricing to limit non-price competition within their market.

What Inventory Behavior Tells Us About Business Cycles

Manufacturers' finished goods inventories move less than shipments over the business cycle. We argue that this requires marginal cost to be more procyclical than is conventionally measured. We construct, for six manufacturing industries, alternative measures of marginal cost that attribute high-frequency productivity shocks to procyclical work effort, and find that they are much more successful in accounting for inventory behavior. The difference is attributable to cyclicality in the shadow price of labor, not to diminishing returns in fact, parametric evidence suggests that the short-run slope of marginal cost is close to zero for five of the six industries. Moreover, while our measures of marginal cost are procyclical relative to output price, they are too persistent for intertemporal substitution to be important. We conclude that countercyclical markups are chiefly responsible for the sluggish response of inventory stocks over the cycle.

Some Evidence on the Importance of Sticky Prices

We examine the frequency of price changes for 350 categories of goods and services covering about 70% of consumer spending, based on unpublished data from the BLS for 1995 to 1997. Compared with previous studies we find much more frequent price changes, with half of prices lasting less than 4.3 months. The frequency of price changes differs dramatically across categories. We exploit this variation to ask how inflation for 'flexible-price goods' (goods with frequent changes in individual prices) differs from inflation for 'sticky-price goods' (those displaying infrequent price changes). Compared to the predictions of popular sticky price models, actual inflation rates are far more volatile and transient, particularly for sticky-price goods. The data appendix for this paper can be found at http://www.nber.org/data-appendix/w9069/

Quantifying Quality Growth

We introduce an instrumental variables approach to estimate the importance of unmeasured quality growth for a set of 66 durable consumer goods. Our instrument is based on predicting which of these 66 goods will display rapid quality growth. Using pooled cross- relatively sections of households in the 1980 through 1996 U.S. Consumer Expenditure Surveys, we estimate quality Engel curves' for 66 durable consumer goods based on the extent richer households pay more for a good, conditional on purchasing. We use the slopes of these curves to predict the rate of quality-upgrading. Just as if households are ascending these quality Engel curves over time, we find that the average price paid rises faster for goods with steeper quality slopes. BLS prices likewise increase more quickly for goods with steeper quality slopes, suggesting the BLS does not fully net out the impact of quality-upgrading on prices paid. We estimate that quality growth averages about 3.7% per year for our goods, with about 60% of this, or 2.2% per year, showing up as higher inflation rather than higher real growth.

Comparative Advantage and Unemployment.

We model unemployment allowing workers to differ by comparative advantage in market work. Workers with comparative advantage are identified by who works more hours when employed. This enables us to test the model by grouping workers based on their long-term wages and hours from panel data. The model captures the greater cyclicality of employment for workers with low comparative advantage. But the model fails to explain the magnitude of countercyclical separations for high-wage workers or the magnitude of procyclical findings for high-hours workers. As a result, it only captures the cyclicality of the extensive, employment margin for low-wage, low-hours workers.

Comparative Advantage in Cyclical Unemployment

We introduce worker differences in labor supply, reflecting differences in skills and assets, into a model of separations, matching, and unemployment over the business cycle. Separating from employment when unemployment duration is long is particularly costly for workers with high labor supply. This provides a rich set of testable predictions across workers: those with higher labor supply, say due to lower assets, should display more procyclical wages and less countercyclical separations. Consequently, the model predicts that the pool of unemployed will sort toward workers with lower labor supply in a downturn. Because these workers generate lower rents to employers, this discourages vacancy creation and exacerbates the cyclicality of unemployment and unemployment durations. We examine wage cyclicality and employment separations over the past twenty years for workers in the Survey of Income and Program Participation (SIPP). Wages are much more procyclical for workers who work more. This pattern is mirrored in separations; separations from employment are much less cyclical for those who work more. We do see for recessions a strong compositional shift among those unemployed toward workers who typically work less.

Heterogeneity and Cyclical Unemployment

We model worker heterogeneity in the rents from being employed in a Diamond-Mortensen-Pissarides model of matching and unemployment. We show that heterogeneity, reflecting differences in match quality and worker assets, reduces the extent of fluctuations in separations and unemployment. We find that the model faces a trade-off-it cannot produce both realistic dispersion in wages across workers and realistic cyclical fluctuations in unemployment.