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

Based on data of individual wage changes, this paper makes an attempt to measure
the frequency and the strength of co-existing nominal and real downward wage rigidity
regimes when the location of the real rigidity bound is can vary across agents. It applies an
empirical strategy which is based on the notion that the observed distribution of individual
wage changes is generated by simultaneous processes of real, nominal or no wage rigidity,
and possibly measurement error. The probabilities that an individual is in one of the
different regimes are estimated by maximum likelihood.
The starting point for the econometric model is the work by Altonji and Devereux
(2000) who measure the incidence of nominal wage rigidity in micro data by referring to
a counterfactual wage change distribution– the wage changes firms would choose in the
absence of rigidity constraints. Identification is based the following consideration: If wages
are rigid, probability mass accumulates at the rigidity bound such that the observed distribution
of wage changes is more skewed than the counterfactual wage change distribution.
Unbiased parameters of the latter can be estimated within the empirical model using the
observations of those individuals whose wages are flexible.
As shown by Dickens and Götte (2002), it is possible to extend this approach to
simultaneously analyze nominal and real wage rigidity. The conceptual difficulty in the
presence of real downward wage rigidity is that the location of the rigidity bound is an
unknown variable. The only previous empirical study that jointly evaluates the incidence
of nominal and real wage rigidity is that by Fehr, Götte, and Pfeiffer (2002). Using
German micro data, they interpret real wage rigidity as contractual rigidity and impose the
condition that the real rigidity bound equals the collective wage agreement applicable to
the agent. The present paper, in contrast, designs the location of the individual real rigidity
bound as a realization from a distribution whose parameters are estimated together with
the other parameters of the model. This approach permits an investigation of the potential
determinants of real wage rigidity. Technically, the model of individual heterogeneity in
real rigidity bounds resembles that developed by Fehr and Götte (2003) for estimating
individual specific threshold values for nominal wage cuts. For the estimation of the
model, we derive individual year-to-year wage changes of prime age West German job
stayers using the Regional File of the IAB Employment Subsample.
Our central finding is that, while wage rigidities are in general substantial, real
downward wage rigidity seems much more pervasive than nominal wage rigidity. This holds
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