RW I:Discussion Papers - Rheinisch-Westfälisches Institut für ...

Measurement error, if it occurs, is rather large, as is indicated by the estimated values for
the standard deviation σ m . This parameter, however, should be interpreted with caution,
since it most likely reflects outliers in the tail of the observed wage change distribution,
which are difficult to explain by the notional wage change distribution. The estimated size
of the standard deviation of the unobserved heterogeneity component impacting notional
wage changes, σ w , appears more reasonable. A range of 0.054 to 0.087 log points is in
line with the variation of individual wage changes in the data. The mean of the estimated
notional wage change distribution is considerably smaller than that of the observed wage
change distribution (compare also Figure 1). This indicates that wage sweep-ups to the
nominal or real rigidity bound due to constrained wage setting are likely to be substantial.
Variation in the individual location of the real rigidity bound is relatively small.
The estimated standard deviation around the mean γ, σ r , is generally less than 0.02 log
points. One possible explanation for this finding is that some collective behavioral pattern
compresses the distribution of the lower bound for wage growth under the real rigidity
regime. The fact that the movement of the estimated mean of the real rigidity bound
is highly correlated with union wage growth (ρ =0.91) seems to be consistent with this
hypothesis. Nevertheless the interpretation that collective wage agreements in a year set
the floor for firms adjusting wages is too simple. As shown in Figure 3, which draws a
confidence band of plus/minus one standard deviation around the real rigidity bound, the
average collective outcome is clearly above the mean of the rigidity bound in numerous
years, especially in the second half of the observation period. Judged by the correlation of
the GDP deflator and γ (ρ =0.86), inflation might as well be the yardstick for minimum
wage growth. From the figure it also emerges, however, that aversion against real wage
cuts does not fully explain the real rigidity bound. A substantial fraction of workers under
the real rigidity regime, if constrained, experiences an increase in the purchasing power of
their wages.
How relevant is this case? Table 4 presents the incidence of the fully flexible as well
as the real and nominal wage rigidity regimes in the private sector as estimated by our
model. Note that the incidences of the three regimes add up to 100%, since each represents
an exclusive state. The real rigidity regime clearly dominates the nominal rigidity regime.
The population share of the nominal rigidity regime, without any strong trend, fluctuates
between 13 and 20 percent throughout the observation period. In contrast, 30 to 70
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