Are Wages Rigid Over the Business Cycle

Search models of the labor market suggest that a significant determinant of job creation decisions by firms is the expected value of the initial and future real wages that firms have to pay to workers in newly formed employment relationships. Until recently, the focus of the empirical literature has been on the cyclical behavior of the current wage, but not on the cyclical behavior of the expected present discounted value of future wages within a match. This article reviews the empirical literature on the cyclicality of real wages of workers in continuing employment relationships, wages of newly hired workers, and a measure of wages that takes into account future wages within employment relationships. The existing evidence suggests that the real wage most relevant for job creation decisions appears to be quite flexible over the business cycle. Thus, the wage data do not support the rigidity necessary to generate the empirical volatility of unemployment in the standard search and matching model.