Unexpected Inflation, Real Wages, and Employment Determination in Union Contracts

Abstract

This paper presents new microeconometric evidence on the relevance of nominal contracting for employment determination in the unionized sector. Real wages in long term union contracts contain an unanticipated component that reflects unexpected changes in prices and the degree of indexation. These unexpected wage components provide a convenient tool for separating the causal effects of wages on employment from other endogenous sources of employment and wage variation. The empirical analysis of employment and wage outcomes among collective agreements in the Canadian manufacturing sector reveals that employment and wages are only weakly related. When unexpected changes in real wages are used as an instrumental variable for the contract wage, however, employment is consistently negatively related to wages. The results imply that the institutional structure of wage determination has important effects on the cyclical characteristics and persistence of employment changes.