SFB 303 Discussion Paper No. A - 562

Author: Bewley, Truman F.
Title: Why Not Cut Pay?
Abstract: This study is intended to be exploratory, touching on many issues in order to test the assumptions and implications of existing theories, to seek new hypotheses, and to see the overall shape of phenomena associated with wage rigidity and unemployment. I use an inductive approach, rather than testing specific models deduced from assumptions based on introspection or economic intuition, the usual strategy in economic research. The advantage of the approach was that I could detect unsuspected phenomena and relationships. However, the resulting breadth of the study increased the difficulty of analyzing the data and of obtaining interviews, and consequently many of my conclusions are tentative, though I am confident of the main ones. The main result of this inquiry is a common sense explanation of downward wage rigidity. The investigation also yielded knowledge of the wage setting process that may prove useful in thinking about economic policy. The findings support none of the theories of wage rigidity except those of Solow (1979) and Akerlof (1982) that stress the impact of pay cuts on morale. My observations are consistent with the Keynesian view that recessions are caused by declines in aggregate demand. Firms had layoffs because of declines in product demand, financial setbacks, or technical improvements, never because of declines in productivity. Increased wage demands were not a cause of unemployment.
Creation-Date: 1997
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