Downward Nominal Wage Rigidity, Inflation and Unemployment: New Evidence Using Micro‐Level Data

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Recent evidence suggests that the extent of downward nominal wage rigidity (DNWR) in the Canadian labour market has risen following the 2008–09 recession (see Brouillette, Kostyshyna and Kyui 2016). This note studies whether DNWR can lead to a long‐run trade‐off between inflation and unemployment, especially at lower rates of inflation—a question that has important implications for the optimal level of inflation in the long run. The results suggest that the trade‐off between unemployment and inflation remains weak despite the estimated increase in DNWR. In particular, the long‐run Phillips curve is close to vertical at inflation rates of 2 per cent or more, in line with earlier findings (Crawford and Wright 2001). As a result, an increase in long‐term inflation from 2 to 3 per cent would lower unemployment by about 0.1–0.2 percentage points. Overall, our results suggest that the benefits of raising the inflation target to attain a lower long‐term unemployment level seem rather weak.