Are nominal wages downwardly rigid? Evidence from Belgian microdata

It is sometimes argued that resistance to nominal wage cuts would justify a moderate amount of inflation in order to “grease the wheels of the labour market”. While empirical studies tend to find that nominal wages are not downwardly rigid in Anglo-Saxon economies, a number of studies suggest that downward nominal wage rigidity is more widespread among continental European countries. This paper attempts to determine empirically whether nominal wages are downwardly rigid in the Belgian labour market. Using the Panelstudie van Belgische Huishoudens for the period 1993-1998, the distribution of annual nominal wage changes is analysed. The analysis does not lead to an unambiguous acceptance or rejection of downward nominal wage rigidity. A number of characteristics of the wage change distribution clearly indicate that wages are not fully flexible and are in line with the assumption that wages are downwardly rigid. The distribution is thinned below zero and a spike at zero wage change is apparent. Both normality and, to a lesser degree, symmetry of the wage change distribution are rejected. Moreover, evidence that supports the menu cost theory is found. Evidence against downward nominal wage rigidity, however, is the high amount of wage cuts that remains after correcting for the definition of the income concept (base pay versus total pay) and after correcting for variation in working hours. If one assumes that these corrections are sufficient, downward nominal wage rigidity may be rejected. It has, however, been argued that measurement error may well account for the rest of the wage cuts. Similar doubt rests on the causes of the spike at zero. How much of the spike is due to downward nominal wage rigidity after accounting for the length of the interview interval, minimum wages and menu costs. It is concluded that the policy recommendation to set higher inflation in order to alleviate the pressure on the labour market requires further investigation. Alain Borghijs Department of Economics University of Antwerp Prinsstraat 13 B 2000 Antwerp [email protected]