Changes in Wage Adjustment, Employment Adjustment and Phillips Curve: Japan's Experience in the 1990s

This paper investigates the change in the adjustment mechanism of Japan's labor market before and after the collapse of bubble economy around early 1990s. Comparison of Phillips curves among industrialized countries shows that Japan's Phillips curve has become much flatter in the 1990s. The steeper Phillips curve before the 1990s would be attributable to nominal wage flexibility reflecting flexible bonus payments or annual spring wage negotiations, slow employment adjustment, and the large discouraged worker effects. On the other hand, the flatter Phillips curve after 1990s and onward would be attributable to the existence of downward nominal wage rigidity under the low and negative inflation rate as well as a decline in discouraged worker effects. Therefore, it is concluded that while slow employment adjustment mechanism did not change so much, fast wage adjustment mechanism deteriorated to some extent due to downward nominal wage rigidity in the 1990s, and also flexible labor supply adjustment such as discouraged worker effects got smaller in the 1990s. We also explore the reasons for a persistent rise in Japan's unemployment rate after collapse of bubble economy, emphasizing a lack of nominal shock absorption due to downward rigidity in nominal wages that created unemployment, slow employment adjustment mechanism that prevented the employment from recovering, and weak discouraged worker effects that kept unemployment rate high.