The Staying Power of Staggered Wage & Price Setting in Macro

The new Handbook of Macroeconomics is now in production as all 34 chapters have been submitted (by 74 different authors).  It will be out later this year. Harald Uhlig and I edited the book, and we each contributed a chapter. My chapter (a draft appears as an NBER Working Paper) is on the staggered price and wage setting model.

The staggered wage and price setting model has had remarkable staying power.  Originating in the 1970s before the advent of real business cycle models, it has been the theory of choice in generation after generation of monetary business cycle models used for policy analysis as Volker Wieland, Elena Afanasyeva, Meguy Kuete, and Jinhyuk Yoo show in their review of over sixty macroeconomic models in their chapter for the Handbook.

But in recent years “Big Data” style research projects have radically expanded knowledge of the microeconomics of wage and price setting behavior from a few salient facts about magazine prices or personal salary experiences into complex data sets with millions of observations. These data sets provide new evidence to test and discriminate between different types of models.

There is new evidence that prices are set at a fixed level for six months or more, especially if sales and reference prices are accounted for properly. There is new evidence that wages are set a fixed level for longer periods and that there is a peak in the estimated hazard function at one year that precludes certain popular simplifications. There is new evidence that both wage and price decisions are staggered or unsynchronized over time, and that this staggering creates a contract multiplier which converts short spells of rigidity at the micro level into longer persistence at the macro level.  There is more evidence of time-dependence than state-dependence. But in each of these dimensions—length, degree of staggering, shape of the hazard function, degree of state-dependence—there is a great deal of heterogeneity across countries, types of product, types of employment, and types of industry structure.

This heterogeneity is not simply a nuisance; it has major implications for aggregate dynamics, and it has been offered as a response to criticism of the models, much of which came after the financial crisis.  Often that criticism applied to a particular simple staggered contract model that does not capture the regularities mentioned above, and the criticism isn’t valid when heterogeneity is taken into account.

In this sense, the implication of this chapter is similar to what Tom Sargent has said about the entire Handbook “This remarkable collection belies uninformed critics who assert that modern macroeconomics was wrong footed by the 2007-2009 financial crisis.”

 

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