| The experience of the collective bargaining process between the representatives of employers and employees during the recent stabilization programs of the 1990’s in Greece showed that the basic objective of the latter has been to at least secure stability in real wage. In particular, a common outcome of almost all negotiations referred to agreements that call for increases in nominal wages over the period of the labor contract, which normally has a duration of two years, equal to expected inflation. There are, however, two main features common in all agreements that are the main cause for the slow adjustment of the nominal wage to actual inflation and thus responsible for the fall in real wage during the two year period of the contract. The first stems from the fact that, the adopted expected inflation upon which the increases in nominal wages are conditioned, normally referred to the one forecasted by the stabilization program of the government, which most of the time was over-optimistic predicting a rather quick disinflation. In case, however, that the actual inflation exceeded the expected one at the end of the contract period, which was normally the case, workers was agreed to receive a “corrective” increase that would equalize the increase in nominal wage with that of actual inflation. The second reason was due to the fact that the agreed increases in nominal wages would be given in four doses over the period of the contract. That is, one at the beginning and another at the middle of each of the two years of the contract period. Thus, the adjustment of nominal wage towards the current inflation was quite slow and was completed only at the end of the contract period and after the “corrective” increase in nominal wages had taken place. As a result, according to the above described Greek experience, we could say that the nominal wage appears quite rigid in the short run and only in the longer run, when all adjustments are completed, the rigidity is transferred to real wage.
The above described Greek experience is introduced into a dynamic macroeconomic model of a small open economy operating under a flexible exchange rate regime with the objective of examining the effectiveness of fiscal and monetary policy. In particular, the model attempts to re-asses the conclusions of the Mundell-Fleming (M-F) classical model by explicitly introducing the supply-side of the economy as well as the specific pattern of wage adjustment. The model constitutes an extension of the Dornbusch (1976) model as it considers the supply-side and introduces slow adjustment in the nominal wage. That is, it assumes nominal wage rigidity in the short run and real wage rigidity in the long-run. Moreover, it also introduces the distinction between the price of domestic output and the overall domestic cost of living (CPI).
In the long run, a nominal monetary expansion has no real effects due to complete nominal wage and price flexibility. This, of course, reverses the conclusions of the M-F model since the nominal wage flexibility keeps the real wage constant and thus prevents any output increase. The situation in the short-run, however, is quite different. In particular, the nominal wage rigidity leads to a partial only increase in CPI leading to a fall in domestic interest rates and to an overshooting in the exchange rate. The depreciation of the exchange rate as well as the fall in real wage lead to an expansion of aggregate supply and as a result output increases in the short run. During the adjustment period, as the nominal wage increases and the nominal exchange rate appreciates the real wage gradually increases which, in turn, reduces supply bringing output back to its initial level.
Turning to fiscal policy, an expansion in nominal government spending in the long-run leads to an increase in output, an appreciation in the exchange rate and a fall in nominal wages and CPI. Again, this result is in conflict with the conclusions of the Mundell-Fleming model. The fall in the nominal wage in the long run prevents the deterioration of competitiveness and thus it cancels out the mechanism through which the initial positive impact of fiscal policy on output is offset in the M-F model. Again, the situation in the short-run is different. More specifically, the slow adjustment in nominal wage causes an over-appreciation of the exchange rate and thus an increase in real wage which, in turn, leads to a fall in the supply of output. This fall in aggregate supply reduces the initially positive impact of fiscal expansion on output. As a matter of fact, output may even fall in the short run if the deterioration in competitiveness more than offsets the favorable impact of the increase in government spending.
Overall, we could say that the degree of flexibility in nominal wages is of critical importance in determining the effectiveness of alternative policy measures. In the present analysis, the basic assumption of real wage rigidity in the long-run reverses the conclusions of the M-F model. In particular, it undermines the effectiveness of monetary policy whose effect turns out to be temporary while, on the other hand, it re-enforces the impact of fiscal policy, whose influence becomes permanent. |
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