The_Wage_Equation

Olivier Blanchard *
April 1998
A central equation in the models we have used so far has been the wage relation,
the relation between the wage set in bargaining between firms and workers, and
labor market conditions. The purpose of this note is to review the state of our
(limited) empirical knowledge on this topic.
1 Empirical wage equations
Start with the standard characterization of the joint behavior of wage inflation,
price inflation, and unemployment in U.S. macroeconometric models.
Standard macroeconometric models determine the natural rate through two
equations, a “price equation” and a ‘&wage equation” In their simplest form, the
equations can be written as:
AlogPt = a,+AlogWt+~,t         (1.1)
AlogWt = a,+AlogPt-I -Pw+~t     (1.2)
where P is the price index, W is the nominal wage, so that A log P and A log W
are price and wage inflation respectively, ‘LL is the unemployment rate, up and a,
are constants, and Q, and E, are error terms.