Download or read book The Effects of Unexpected Inflation on Real Wages written by Yo-Un Yoon and published by . This book was released on 1996 with total page 348 pages. Available in PDF, EPUB and Kindle. Book excerpt: The objective of this paper is to examine whether nominal rigidities make real wages respond significantly to expected and unexpected inflation. Preliminary empirical results support the hypothesis that nominal rigidities prevent the nominal wage adjusting to the movements of inflation. A simple general equilibrium model of Blanchard and Fischer (1989) that incorporates nominal wage contracts and wage indexation is employed to analyze the theoretical implications of the effects of expected and unexpected inflation on real wages. The model suggests that the one-period nominal wage contract without an indexation provision makes real wages uncorrelated with expected inflation but correlated with unexpected inflation. The main empirical models derived from the Blanchard and Fischer's framework suggest that the responses of real wages to inflation shocks are different depending on whether the shocks are driven by demand or supply shocks. The main empirical results support the Blanchard and Fischer's model in that real wages respond differently to demand and supply driven inflation shocks. The main findings of this paper are that the statistically significant effects of contemporaneous and lagged inflation shocks on real wages provide evidence for the presence of nominal rigidities in the economy. In particular, the extent of the rigidity varies depending on the nature of inflation shock; positive, negative, demand driven and supply driven shocks. For example, the nominal wage is more rigid against positive inflation shocks than negative counterparts. This suggests that nominal wages are rigid more in the upward direction than in the downward direction. Thus, this result provides contradictory evidence to the Keynesian belief that wages are downwardly more rigid. Also the results suggest that nominal wages are slightly more rigid against supply driven shocks than demand driven shocks. The extent of responses of durable and nondurable real wages to demand driven inflation shocks suggests that the government's unexpected demand policy can be effective during both economic recessions and expansions.