Inflation and unemployment affect wage rigidity, Icelandic authors find

Two Icelandic economists present evidence that nominal wage rigidity is determined endogenously, in contrast to standard New Keynesian models, in a paper published in the Journal of Monetary Economics.

Rannveig Sigurdardottir, deputy chief economist at the Central Bank of Iceland, and Jósef Sigurdsson, formerly an economist at the central bank, study a unique set of administrative micro-data on the Icelandic labour market in their paper, Time-dependent or state-dependent wage-setting? Evidence from periods of macroeconomic instability.

They find the timing of wage adjustments depends on the level of inflation and unemployment, and note further that following sharp macroeconomic shocks, the frequency of wage cuts rises, in contrast to theories emphasising the downward rigidity of wages.

"It is clear from our results that frequency of wage changes is determined endogenously in the economy," they say. "The failure of macroeconomic models to account for this feature could result in false conclusions about the real effect of monetary policy."