The Great Depression has led policymakers, commentators, and academics to question the ability of monetary policy to affect real activity. As is well known, in standard New-Keynesian models (Galí 2015) policy non-neutrality is stronger the higher the degree of rigidity. The degree of wage rigidity is also different across countries, or regions and sectors belonging to the same country, leading to asymmetric effects of monetary policy and possible regional misallocation. The latter is also crucial for understanding spatial inequality. Quantifying the impact of monetary policy, a long-standing question in economics, requires an accurate measurement of nominal rigidities. This is typically a challenging task and requires the use of detailed, often confidential, micro data. While
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The Great Depression has led policymakers, commentators, and academics to question the ability of monetary policy to affect real activity. As is well known, in standard New-Keynesian models (Galí 2015) policy non-neutrality is stronger the higher the degree of rigidity. The degree of wage rigidity is also different across countries, or regions and sectors belonging to the same country, leading to asymmetric effects of monetary policy and possible regional misallocation. The latter is also crucial for understanding spatial inequality.
Quantifying the impact of monetary policy, a long-standing question in economics, requires an accurate measurement of nominal rigidities. This is typically a challenging task and requires the use of detailed, often confidential, micro data. While much progress has been made in measuring the effects of nominal rigidities in output prices (Gorodnichenko and Weber 2015), we have less evidence on the role of flexibility in the wage adjustment process. However, measuring such rigidities with micro data is important for at least two reasons. First, given that wage rigidity is likely to vary between firms or sectors, an exact assessment of those rigidities allows researchers to quantify the heterogenous effects of monetary policy. Second, relatively inflexible wage bargaining regulations or practices may prevent firms from reacting to aggregate shocks in a timely manner, such as in monetary policy decisions. Quantifying these costs is crucial for understanding the extent of spatial and sectorial misallocation, and for the design of appropriate labour market policies.
Monetary policy in the presence of collective agreements
In our recent work (Faia and Pezone 2018), we focus on Italy – a single, fairly integrated labour market. We do so for two reasons. First, wage setting is still fairly centralised and firm-level bargaining plays a relatively minor role, similarly to other countries in Western Europe (Ichino et al. 2019). Hence, our results may serve as a useful benchmark. Second, we can make use of a unique employee-employer dataset comprising the universe of workers employed in the private sector, which we access through the project “VisitINPS Scholars Program” at the Italian Institute of Social Security. We combine this dataset with intraday data on stock returns, as well as hand-collected information on renewals of collective agreements, which typically last two or three years. We then test, using high-frequency identification, whether wage rigidity induced by collective bargaining amplifies the effects of monetary policy.
The intuition we exploit is straightforward and relies on the fact that a firm may be hit by a shock at different stages of the ‘life’ of its workers’ collective agreement. If the monetary policy shock occurs when the agreement is close to the renewal, any change in firm profitability due to a macroeconomic shock will be promptly accounted for in the new contract. On the other hand, if there is a long time left before the renewal, workers and managers will be ‘stuck’ with the wage previously agreed upon, despite the fact that firm profitability might have drastically changed. Hence, in this case the impact of a change in the central bank’s policy will have stronger effects on firm valuations.
An example clarifies our strategy. On September 4, 2014, Mario Draghi unexpectedly announced a 10 basis points cut to the deposit facility rate, one of the main ECB target rates. The collective agreement in force for the ‘Telecommunication’ industry in Italy was set to expire at the end of the same year. Workers employed by ‘Large Glass Producers’, instead had their agreement in force until August 31, 2015. Suppose the shock was effective in boosting demand, and hence firm output. An increase in revenues should, generally, translate into higher workers’ wages. However, this pass-through was set to occur much later for workers employed by glass producers. Hence, the employers in this sector should have enjoyed a larger boost in profits than those in the telecommunication industry. This differential response should be reflected in stock market valuations and in employment levels. Based on a simple theoretical framework, inspired by work by Fischer (1977) and Taylor (1979), we predict that the distance to contract renewal will amplify the effects of monetary policy on the volatility of stock returns and employment.
The costs of wage rigidity
In our empirical design, we exploit high frequency identification of monetary policy shocks. Because market valuations will react only to new information, we need to extract the unexpected component of monetary policy decisions. Following previous work, we measure monetary policy shocks via changes in swap rates on the Euro OverNight Index Average (EONIA), shortly after and before the time an ECB meeting takes place (Gürkaynak et al. 2005, Barakchian and Crowe 2013, Corsetti et al. 2018).
There is not a one-to-one correspondence between a firm’s sector and the relevant collective agreement. However, thanks to the detailed information available in the VisitINPS data, we aggregate, at the firm-month level, hand-collected information on the time that individual workers have left prior to their contract renewal to construct a proper proxy for wage stickiness.
Using a large sample of listed Italian firms between 2005 and 2016, we find results consistent with our hypothesis. More specifically, we find that the volatility of stock market returns reacts more to monetary policy announcements when the average time left before the renewal of the employees’ collective agreement is large. These effects are quantitatively important. The sensitivity of volatility increases by about half for firms that have wage stickiness one standard deviation above the mean. In further tests, we find that this amplification channel is stronger for firms that experience low profitability and at times of low economic growth.
We obtain similar results when we focus on changes in employment levels, measured at quarterly frequencies. Importantly, workers with short-term contracts, who tend to be younger and to have lower bargaining power, appear to be those more exposed to the amplification induced by rigid contracts. These effects are consistent with the predictions of a rigorous general equilibrium model we develop to interpret the results.
Overall, our findings show that the response to monetary policy shocks is heterogeneous and depends on the degree of nominal rigidities, as well as on firms’ characteristics, suggesting that monetary policy can have important distributional consequences. While we focus on the heterogeneous response of firms to monetary policy shocks, our basic empirical strategy and our laboratory economy can be adapted to study the response to other common events, such as trade shocks.
Our results also support the hypothesis that rigidly centralised wage bargaining agreements can prevent, at least in part, firms from absorbing aggregate shocks. Hence, the heterogeneity in labour market practices and regulations in Europe (Di Mauro and Ronchi 2017) is likely to generate different responses to monetary policy across economies of the euro area.
Barakchian, S M, and C Crowe (2013), “Monetary Policy Matters: Evidence from New Shocks Data”, Journal of Monetary Economics 60, 950–966.
Boeri, T, A Ichino, E Moretti and J Posch (2019), “Wage Equalization and Regional Misallocation: Evidence from Italian and German Provinces”, CEPR Discussion Paper 13345.
Corsetti, G, J B Duarte, and S Mann (2018), “One Money, Many Markets - A Factor Model Approach to Monetary Policy in the Euro Area with High-Frequency Identification”, Working Paper.
Faia, E, and V Pezone (2018), “Monetary Policy and the Cost of Heterogeneous Wage Rigidity: Evidence from the Stock Market”, SAFE Working Paper 242.
Fischer, S (1977), “Long-Term Contracts, Rational Expectations, and the Optimal Money Supply Rule”, Journal of Political Economy 85, 191–205.
Galí, J (2015), Monetary Policy, Inflation, and the Business Cycle: an Introduction to the New Keynesian Framework and its Applications, Princeton University Press.
Gorodnichenko, Y, and M Weber (2016), "Are Sticky Prices Costly? Evidence from the Stock Market," American Economic Review 106 (1), pages 165-199.
Gürkaynak, R S, B Sack, and E T Swanson (2005), “Do Actions Speak Louder Than Words? The Response of Asset Prices to Monetary Policy Actions and Statements”, International Journal of Central Banking 1, 55–93.
Ichino, A, T Boeri, E Moretti, and J Posch (2019), "Wage Equalization and Regional Misallocation: Evidence from Italian and German Provinces”, CEPR Discussion Paper 13545.
Ronchi, M, and F di Mauro (2017), "Wage Bargaining Regimes and Firms' Adjustments to the Great Recession”, ECB Working Paper 2051.
Taylor, J B (1979), “Staggered Wage Setting in a Macro Model”, American Economic Review, 108–113.