The Impact of Downward Nominal Wage Rigidity on the Unemployment Rate: Quantitative Evidence from Japan

To what extent does downward nominal wage rigidity (DNWR) raise the unemployment rate during periods of low inflation or deflation? To answer this question, we simulate the impact on the male unemployment rate in Japan, by incorporating the DNWR of full-time male employees as estimated by Kuroda and Yamamoto into the general equilibrium model of Akerlof et al. The simulation results show the following. First, the DNWR estimated by Kuroda and Yamamoto with Japanese longitudinal data from 1993-98 has a minor impact on the unemployment rate compared with the case of perfect DNWR. Nevertheless, this impact is not trivial in the sense that it raises the unemployment rate by as much as 1.8 percentage points under the baseline parameters adopted in this paper. Second regarding the relationship with the rate of inflation, DNWR does not cause unemployment as long as the inflation rate is approximately 2.4 percent or higher whereas its effects tend to increase gradually as the inflation rate falls below 2.4 percent. When inflation is below approximately 1 percent, however, the marginal increase in unemployment attributable to DNWR is small since DNWR is moderated by the adjustments to bonuses and extensive wage cuts observed in our Japanese data sets. Instead, under these conditions, it is the additional unemployment brought by labor market distortions that becomes the issue.