the in-phase buffer response to high demand discussed above. Changes in ʌ,
by contrast, may represent a longer term restructuring of work organisation.
The view taken in the bulk of the existing literature is that the standard
nominal wage, W, is likely to be influenced by economic conditions occurring
over the entire spectrum of the business cycle. A firm’s wage contract negotia-
tions are undertaken, typically, at regular and pre-determined intervals. Even
allowing for consideration of anticipated and historic economic extrapolations,
nominal wage changes are likely partially to reflect prevailing short-run eco-
nomic conditions at all stages of business activity. For this reason, economists
have tended to use cyclical changes in output or employment or unemployment
to represent such business cycle effects. But the degree of contemporaneous
association with the cycle may be limited. Economic forecast errors, commu-
nications problems involving asymmetric information and time delays between
contract negotiation and implementation may serve to produce pro-cyclical
wage changes that are out of phase with the actual business cycle. Added
to this, any given cycle indicator may itself respond less than immediately to
actual business activity. Employment- and unemployment- related indicators
are well known to be particularly prone to this type of problem.
3.2 Real earnings and the choice of price deflator
Time series analysts have found that the choice of price deflator has a strong
bearing on the observed degree of cyclical wage responsiveness (for example
Abraham and Haltiwanger, 1995). Generally, wages deflated by consumption
prices, Cp, are found to be more pro-cyclical than wages deflated by produc-
tion prices, Pp. We label these, respectively, consumption and production
wages. This comparative observation appears to be confined to real wage re-
sponsiveness to the business cycle. However, it is not necessarily the case
that business-related cycles are the only significant determinant of changes in
prices, and especially producer prices.
Producer prices refer to the entire marketed output of firms. They include
goods and services purchased by other Erms as production inputs or capital
investments. In these latter respects, and following Caballero and Hammour
(1994), suppose that some firms treat a given recessionary period as a time to
scrap outdated capital and to invest in product and process innovations. The
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