The frequency of nominal wage adjustments varies with macroeconomic conditions. Existing macroeconomic analyses exclude such state dependency in wage setting, assuming exogenous timing and constant frequency of wage adjustments under time-dependent setting (e.g., Calvo- and Taylor-style setting). To investigate how state dependency in wage setting influences the transmission of monetary shocks, this paper develops a New Keynesian model in which the timing and frequency of wage changes are endogenously determined in the presence of fixed wage-setting costs. I find that state-dependent wage setting reduces the real impacts of monetary shocks compared to time-dependent setting. Further, with state dependency, monetary nonneutralities decrease with the elasticity of demand for differentiated labor, while the opposite holds under time-dependent setting. Next, this paper examines the empirical importance of state dependency in wage setting. To this end, I augment the model with habit formation, capital accumulation, capital adjustment costs, and variable capital utilization. When parameterized to reproduce the fluctuations in wage rigidity observed in the U.S. data, the state-dependent wage-setting model shows a response to monetary shocks quite similar to that of the time-dependent counterpart. The result suggests that for the U.S. economy, state dependency in wage setting is largely irrelevant to the monetary transmission.
State Dependency in Price and Wage Setting
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