Pre-recession wage inflation and the strength of the subsequent recovery

ABSTRACT

This study shows that the rate of wage inflation in the year before a recession is positively related to the rate of employment growth in the subsequent recovery. A possible explanation for this relationship is downward nominal wage rigidity. It is also found that the prior rate of wage inflation is not significantly related to the employment decline during the ensuing recession, suggesting that prior wage inflation has a greater impact on the strength of the recovery from a recession than on the severity of the recession.

KEYWORDS:

• Wage inflation
• recovery strength
• wage rigidity

JEL CLASSIFICATION:

• E24
• E32
• J30

Acknowledgement

I would like to thank Evan Anderson and John Duca for helpful comments on earlier versions of this article

Disclosure statement

No potential conflict of interest was reported by the author.

Notes

¹ The employment figures are the Bureau of Labor Statistics’ estimates of total nonfarm employment.

² Mathematically, , where m is the number of months between the trough and recovery.

³ Another wage variable that has been collected since 1947 is hourly compensation, but this variable is a problematic measure of the marginal cost of labour because the numerator and denominator of this variable come from different sources and because it includes proprietors’ income, bonus and profit-sharing payments, and realizations of stock options, as well as wages and salaries.

⁴ In the year following peak employment, the growth rate of AHEGP decreased by an average of 5.48% in pre-1964 recessions. In post-1964 recessions (excluding the 1980 recession, during which wage inflation actually rose), the growth rate of AHEGP fell, on average, by 0.46%.

⁵ For example, Campbell (2014) simulates the response of unemployment and wage inflation to an adverse demand shock and shows that simulated wage inflation is positive when employment is decreasing and becomes negative when employment starts to rise, meaning that downward nominal wage rigidity would not become binding in this model until employment starts to recover.