Procyclical Real Wages Under Nominal-Wage Contracts With Productivity Variations

A frequent criticism directed at many macroeconomic models, especially those with wage stickiness, concerns their inability to account for the procyclical pattern of real wages. This article offers a resolution of this problem by introducing productivity factors into the determination of sticky wages. This resolution makes the resulting model more consistent with standard microeconomic theory about the determination of wages. The problem of accounting for real-wage cyclicity arises both for sticky-wage models such as those of Keynes (1936) and Fischer (1977), and for the incomplete-information models such as those of Friedman (1968) and Lucas and Rapping (1969). Economists favoring these models have offered a wide variety of prospective solutions to the puzzle of real-wage cyclicity, including complex reinterpretation of the evidence and a variety of modifications to the models. However, none of these solutions has been widely accepted and the failure of proponents of these models to resolve the real-wage puzzle has been considered a serious shortcoming of the models. The inability of existing sticky-wage and incomplete-information models to account for the cyclicity of the real wage has given impetus to the development of two alternative explanations of macroeconomic fluctuations. These James G. Hoehn is an economist at the Federal Reserve Bank of Cleveland. The author gratefully acknowledges helpful discussions with Charles T. Carlstrom, William T. Gavin, and Alan C. Stockman, and acknowledges useful comments on a draft by Randall W. Eberts, Erica L. Groshen, and John B. Taylor.