Abstract
This paper raises two questions associated with the price level inertia. Is price setting behavior important as much as wage setting behavior in explaining price level inertia? If it is, then does price setting behavior depend on the level of inflation? The answers to these questions are both yes. Recent empirical study concerning the adjustment of prices and wages has found two evidence in the U.S. First, the speed of aggregate adjustment is roughly the same for wages to prices and for prices to wages. Second, price adjustment depends positively on inflation rates, but wage adjustment does not. This paper examines cross-country evidence on the aggregate adjustment of prices to wages and that of wages to prices with inflation rates. The aggregate adjustment of prices to wages is at least important as much as that of wages to prices in explaining the price level inertia in most countries. Hence, it is not true to simply assume that wages are more rigid than prices in macroeconomic model.
Cross-country evidence also indicates that inflation plays a significant role in explaining price setting behavior. Higher inflation makes prices adjust faster to wages, thereby reducing price level inertia. The aggregate adjustment of prices to wages is faster in countries with high inflation and slower in countries with low inflation. But this channel does not hold with wage setting behavior. The aggregate adjustment of wages to prices has nothing to do with inflation rates.
Country-specific wage setting pattern such as centralized bargaining agreements or high degree of indexation does not play a significant role in reducing the price level inertia. Moreover, the degree of indexation does not depend much on inflation rates. From all this cross-country evidence, I conclude that price setting behavior is at least important as much as wage setting behavior in explaining the price level inertia in most countries, and the level of inflation is primarily responsible for the aggregate adjustment of prices to wages. The importance of price setting behavior implies that countries with different institutional factors in the labor market are likely to show, at least at a given average rate of inflation, similar behavior in the price level inertia and movements of real output.