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Inflation and unemployment revisited: Grease vs. sand

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  • Groshen, Erica L.
  • Schweitzer, Mark E.

Abstract

As inflation rates in the United States decline, analysts are asking if there are economic reasons to hold the rates at levels above zero. Previous studies of whether inflation greases the wheels of the labor market ignore inflation's potential for disrupting wage patterns in the same market. This paper outlines an institutionally-based model of wage-setting that allows the benefits of inflation (downward wage flexibility) to be separated from disruptive uncertainty about inflation rate (undue variation in relative prices). Our estimates, using a unique 40-year panel of wage changes made by large mid-western employers, suggest that low rates of inflation do help the economy to adjust to changes in labor supply and demand. However, when inflation's disruptive effects are balanced against this benefit the labor market justification for pursuing a positive long-term inflation goal effectively disappears.

Suggested Citation

  • Groshen, Erica L. & Schweitzer, Mark E., 1998. "Inflation and unemployment revisited: Grease vs. sand," CFS Working Paper Series 1999/06, Center for Financial Studies (CFS).
    • Handle: RePEc:zbw:cfswop:199906
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    References listed on IDEAS

    as
    1. Lach, Saul & Tsiddon, Daniel, 1992. "The Behavior of Prices and Inflation: An Empirical Analysis of Disaggregated Price Data," Journal of Political Economy, University of Chicago Press, vol. 100(2), pages 349-389, April.
    2. Erica L. Groshen & Mark E. Schweitzer, 1994. "The effects of inflation on wage adjustments in firm-level data: grease or sand?," Working Papers (Old Series) 9418, Federal Reserve Bank of Cleveland.
    3. Shapiro, Carl & Stiglitz, Joseph E, 1984. "Equilibrium Unemployment as a Worker Discipline Device," American Economic Review, American Economic Association, vol. 74(3), pages 433-444, June.
    4. Sparks, Roger, 1986. "A Model of Involuntary Unemployment and Wage Rigidity: Worker Incentives and the Threat of Dismissal," Journal of Labor Economics, University of Chicago Press, vol. 4(4), pages 560-581, October.
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    More about this item

    Keywords

    Inflation; Nominal Wage Rigidity; Wage Setting;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • J30 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - General

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