The Cyclical Behavior of Real Wages: A Survey of Theory and Evidence

Abstract

This paper presents a survey of the theory and evidence on the cyclical behavior of the real wage. I begin with a traditional neo-classical synthesis view. This view holds the real wage to be counter-cyclical. I then analyze various other studies by looking at their results and the different variables they employ. Additionally, I discuss the real business cycle model as a possible way to accommodate a pro-cyclical real wage. Also, a new Keynesian response to a pro-cyclical real wage is examined. A problem in studying the cyclical behavior of the real wage is the complexity involved in formulating data and evidence to examine. Each study chooses different variables within their research. It should not be surprising that studies contradict one another considering the different measurements and specifications they make. Factors which influence a study's results and create contradictions among studies include the use of consumption versus production deflators, adjustment for industry mix and overtime, the type of data used, the time period studied, and the choice of a cyclical indicator. The uncertainty that exists creates a hot debate among macroeconomists. Some studies uncover a pro-cyclical real wage, while others find a counter-cyclical real wage. The cyclicality of the real wage has different implications for different theories. Real business cycle theory and its use of technological shocks accommodate a pro-cyclical real wage. This pro-cyclical real wage is strongly imbedded in the real business cycle models. In addition, this paper cites that new Keynesian models with imperfect competition can yield pro-cyclical real wages, although this is not the traditional new Keynesian view. Neo-classical synthesis, however, traditionally holds the real wage to be counter-cyclical. Moreover, they do not find any way to explain a pro-cyclical real wage within their theory. As seen above, different macroeconomic theories have different opinions on the cyclical behavior of the real wage. Yet, the inconclusive evidence in the study of the real wage does not create any reason to alter any macroeconomic theories. At this point in the search for the behavior of the real wage it is difficult to say what the outcome will be. The cyclical behavior of the real wage is an ongoing debate that may never be concluded.