The Changing Cyclical Responsiveness of Wage Inflation

Abstract

A POPULAR THEME in discussions of stabilization policy is that inflation -wage inflation, in particular-is becoming less responsive to changes in unemployment and to the forces of aggregate demand in general.The view is that wages today respond only slightly to unemployment and vary more closely with prices, which in turn depend most on cost variables.Since the cost variables are essentially prices (and wages are the most significant single price), the system reduces to a highly autoregressive model, with unemployment or demand seemingly playing a minor and shrinking role.The government-engineered recession applied to cure inflation in 1969-70 was judged to be a failure.This judgment has led many economists to argue that monetary and fiscal policy simply takes too long to slow inflation; and the 1973-74 slowdown and the sharper 1974-75 decline seem to reinforce these views.Some never believed that recessions significantly slowed inflation; others lost their faith in them after the late 1950s.Since the social costs presumably become larger the smaller the adjustment of wages to unemployment and to aggregate demand in general, the issue of "changing responsiveness" has become a central concern to policymakers and is the focus of this paper.