Incomplete Capital Markets, Wage Formation and Stabilization Policy
CES Working Paper at Univ. of Munich No. 123
Posted: 5 Feb 1997
Date Written: December 1996
The future purchasing power of wage income may become risky in the presence of capital market imperfections. Current nominal wages, therefore, have intertemporal implications which in turn affect wage determination. The influence of consumption risk on wage setting is analyzed in a general equilibrium model with an imperfectly competitive labor market (monopoly union). It is shown that the adjustment process implies wage smoothing and nominal rigidities. Nominal wages are less flexible than prices, and there is more persistency in wage than in price adjustment. Moreover, employment shows more variability over the business cycle than real wages no matter whether the cycle is driven by supply or demand shocks. An active demand management policy is shown to affect risk and, therefore, real allocations and to be potentially Pareto improving.
JEL Classification: E30, J30
Suggested Citation: Suggested Citation