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Wage Formation under Low Inflation

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Collective Bargaining and Wage Formation

Abstract

This paper reviews the literature on the effects of low steady-state inflation on wage formation, focusing on four different effects. First, under low inflation, downward nominal wage rigidity (DNWR) may prevent real wage cuts that would have happened had inflation been higher. Second, wages (and prices) are given in nominal contracts, and inflation affects both how often wages are adjusted, and to what extent wages are set in a forward-looking manner. Third, incomplete labour contracts may provide workers with scope for inflicting costs on the firm without violating the contract, thus forcing the firm to accept a rise in nominal wages. Fourth, if effort depends on wages relative to a reference level, and workers and firms underweight inflation when updating the reference level, positive but moderate inflation may reduce wage pressure. The paper ends by a brief survey of empirical evidence, and a discussion of whether labour markets may adapt to a low inflation environment.

I wish to thank Mike Elsby, Karl Ove Moene, Tapio Palokangas, an anonymous referee and participants at the conference “Collective bargaining and wage formation”, Helsinki, for useful comments on a previous draft.

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Authors and Affiliations

  1. Department of Economics, University of Oslo, Norway

    Steinar Holden

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  1. Steinar Holden
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Editors and Affiliations

  1. ETLA, Lönnrotinkatu 4 B, 00120, Helsinki, Finland

    Hannu Piekkola Ph.D.

  2. Labour Institute for Economic Research, Pitkansillanranta 3 A, 00530, Helsinki, Finland

    Kenneth Snellman Ph.D.

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Holden, S. (2005). Wage Formation under Low Inflation. In: Piekkola, H., Snellman, K. (eds) Collective Bargaining and Wage Formation. Physica-Verlag HD. https://doi.org/10.1007/3-7908-1598-5_4

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