December 2003

IZA DP No. 959: Real and Nominal Wage Rigidities and the Rate of Inflation: Evidence from West German Micro Data

revised version published in: Economic Journal, 2007, 117, 508-529

The paper examines real and nominal wage rigidities. We estimate a switching regime model, in which the observed distribution of individual wage changes, computed from West German register data for 1976-1997, is generated by simultaneous processes of real, nominal or no wage rigidity, and measurement error. The fraction of workers facing wage increases that are due to nominal, but mostly real wage rigidity is substantial. The extent of real rigidity rises with inflation, whereas the opposite holds for nominal rigidity. Overall, the incidence of wage rigidity, which accelerates unemployment growth, is most likely minimized in an environment with moderate inflation.