Sticky Consumption and Rigid Wages

Abstract

A common explanation for the rise in European unemployment in the 1970s and early 80s has been based on the increase in import prices due to the oil and commodity price shocks.¹ If workers resist the negative impact on the real wage, an import price shock will cause a rise in unemployment. In their influential book on unemployment, Layard, Nickell and Jackman (1991, p. 31) explain the existence and consequences of real wage resistance in the following way:

Workers value not only the level of their real consumption wage, but also how it compares with what they expected it to be…. When external shocks like import price shocks, tax increases, or falls in productivity growth reduce the feasible growth of real consumption wages, this generates more wage pressure, which (in equilibrium) requires more unemployment to offset it.