Revisiting Real Wage Rigidity

In this paper, we provide empirical evidence that real wage rigidity is not
a major cause of unemployment volatility. We argue that there is a disconnect
between the theoretical and empirical literatures on this topic. While
theoretical studies define real wage rigidity as the response of wages to
changes in unemployment following productivity shocks, the empirical literature
measures real wage rigidity as the estimated semi-elasticity of wages
with respect to unemployment, averaged over all shocks. We show that averaging
over shocks gives a biased measure of real wage rigidity, as the impact
of other shocks confounds the response to productivity shocks. Our
results indicate that the estimated semi-elasticity with respect to productivity
shocks is twice as large as the estimated semi-elasticity averaged over
all shocks. This implies that one cannot attribute unemployment volatility
to real wage rigidity