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Real wage and nominal shock: evidence from Pacific-rim countries.

Article Excerpt
Abstract

This paper examines aggregate real-wage responses to nominal shocks in four Pacific-rim countries utilizing a vector autoregression (VAR) framework. In this study, positive real-wage responses are found in Japan and New Zealand whereas negative responses are found in Australia and Korea. In the transmission of nominal shocks to real economic activities, the findings show a sticky-price model to be more important in Japan and New Zealand, while a sticky-wage model plays the more dominant role in Australia and Korea. (JEL E4, E5)

Introduction

Neoclassical theory of employment typically predicts a negative correlation between real wage and output (or employment) due to diminishing returns to labor in the short run. When there is a growth rate of current output in the short run that exceeds a long-run normal growth rate of output, this short-run growth is attributable to an increase in employment relative to the normal trend, which will result in a decline in the real wage below the normal level [Otani, 1978]. Since the early works of Dunlop [1938] and Tarshis [1939], many economists [Neftci, 1978; Otani, 1978; McCallum, 1986; Gamber and Joutz, 1993; Christiano et al., 1997; Spencer, 1998; Barth and Ramey, 2002] have shown (empirical) relationships between the real wage and the output with economic shocks (both demand- and supply-side) over the business cycle.

There is a general consensus among economists that when a supply-side shock exists, there is a positive correlation between the real wage and the output. However, when there is a demand-side shock, the relationship is not as clear as the one under the supply-side shock; the real wage responds either positively or negatively depending on the relative stickiness of output price and wage. Any models that assume sticky prices predict a strong procyclical relationship between the real wage and the output when there is a demand-side shock [McCallum, 1986; Gamber and Joutz, 1993; Christiano et al., 1997; Barth and Ramey, 2002]. In contrast, any models that assume sticky wages predict a strong countercyclical relationship between the real wage and the output to the same demand-side shock [Spencer, 1998]. However, it is believed the sticky-price theory is more dominant in the transmission of any nominal demand shocks to real economic variables such as the real wage and the output due to more procyclical real wage activities found empirically; hence, a more positive correlation exists between the real wage and the output.

In this study, vector autoregression (VAR) models are built to identify the correlation between the real wage and the output by investigating the real wage responses to aggregate demand-side shocks. This paper further identifies the real-wage responses to demand-side shocks in four Pacific-rim countries (Australia, New Zealand, Japan and South Korea [hereafter Korea]) as few previous studies paid attention to countries other than the U.S. Therefore, the real-wage responses in this paper will further shed light on the importance of the relative...

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