On the cyclicality of real wages and wage differentials

Abstract

Abstract Previous empirical literature suggests that estimated wage cyclicality depends on the structure of the relationship between real wages and an observed indicator of the business cycle that econometric models impose prior to estimation. This paper, alleviates the problem of imposing such structure by searching directly for the largest common cycles in longitudinal microdata using a Bayesian dynamic latent factor model. We find that the comovement of real wages is related to a common factor that exhibits a significant but imperfect correlation with the national unemployment rate. Among others, our findings indicate that the common factor explains, on average, no more than 9% of wage variation, it accounts for 20% or less of the wage variability for 88% of the workers in the sample and roughly half of the wages move procyclically while half move countercyclically. These facts are inconsistent with claims of a strong systematic relationship between real wages and business cycles.