The Wage-Price Spiral International

Journal of Economics and Business 59 (2007) 212–240
The wage–price spiral: International

evidence and implications
Magda Kandil ∗
International Monetary Fund, 700 Nineteen St., N.W., Washington,
DC 20431, United States
Received 23 August 2005; received in revised form 27 January 2006; accepted 7 April 2006
Abstract
Using time-series quarterly data for 12 industrial countries, the dynamics of nominal wage and price
adjustments in the face of aggregate demand shocks varies with conditions in labor and product markets and
in the face of positive and negative demand shocks. During expansions, the simultaneous overlap of nominal
adjustments in labor and product markets prolongs output expansion while maintaining or increasing the
real standard of living. In contrast, structural and institutional settings appear to have moderated the severity
of contractionary demand shocks on real output growth and the real standard of living.
© 2006 Elsevier Inc. All rights reserved.
JEL classiﬁcation: E30; E31; E32
Keywords: Wage; Price; Spiral
1. Introduction
The spill-over effects of nominal adjustments of wages and prices across labor and product
markets are commonly known as the wage–price spiral. An increase in aggregate demand prompts
firms to adjust nominal prices upward to maintain or increase their markup of prices over wages.
Concurrently, workers attempt to adjust nominal wages upward to maintain or increase their real
wages. After a decrease in aggregate demand, the process of adjustment of nominal wages and
prices are consistent with a simultaneous reduction in profit markups and real wages. Wage–price
setting may be instantaneous or staggered, allowing for a slow process of nominal adjustment.
Theory predicts that the more inflexible real wages and markups are to demand shifts, the slower
∗ Tel.: +1 202 623 4696; fax: +1 202 589 4696.

E-mail address: mkandil@imf.org.
0148-6195/$ – see front matter © 2006 Elsevier Inc. All rights reserved.
doi:10.1016/j.jeconbus.2006.04.004
M. Kandil / Journal of Economics and Business 59 (2007) 212–240 213
the process of nominal adjustment of wages and prices towards full-equilibrium and the longer-
lasting are output fluctuations. Intuitively, nominal adjustment, e.g., in the face of expansionary
demand shocks, would start an upward spiral of wage–price adjustments that would stop only if
the reduction in real money balances offsets demand expansion.
The proposition of this paper is that the dynamics of the wage–price spiral is likely to vary
with conditions in labor and product markets of various economies. Further, these conditions may
differentiate the dynamics of adjustments within a given economy in the face of positive and
negative demand shocks.
The theoretical background of the paper builds on the details of the framework in Blanchard
(1986). Underlying this framework are two main assumptions that seek to approximate real world
conditions. The first is monopolistic competition in the goods and labor markets. The second is
staggering of price and wage decisions. These two assumptions generate the conditions that may
determine the dynamics of wage and price spirals.
Given similar conditions of monopoly power and price setting in labor and product markets,
the wage–price spiral does not produce a systematic correlation between output and real wage
adjustments to demand shocks. Lack of correlation is the result of attempts by workers to maintain
their real wage and by firms to maintain their profit markups. A higher degree of wage flexibility
in the labor market produces a positive correlation between real wage and output adjustments to
demand shocks. In contrast, a higher degree of price flexibility in the output market produces a
negative correlation between the real wage and output adjustments to demand shocks.
Relaxing the assumption of similar conditions in labor and product markets is likely to highlight
asymmetry in real wage adjustments to demand shocks. A strand of the theoretical literature has
viewed asymmetry of economic fluctuations to be a supply-side phenomenon. Demand shifts along
a kinked supply curve are likely to produce varying effects on the economy. In one direction, some
have explained the asymmetric shape of the supply curve by conditions in the labor market. The
stipulation of wage contracts may allow for asymmetric wage indexation. For example, if wages
are more upwardly flexible the aggregate supply curve is steeper in the face of expansionary
demand shocks compared to contractionary shocks.1 Alternatively, supply-side asymmetry may
be attributed to conditions in the product market. Faced with menu costs, firms maybe inclined for
more frequent and larger adjustments of prices in the upward direction compared to the downward
direction. This scenario is consistent with a steeper supply curve in the face of positive demand
shocks compared to negative shocks.2
The empirical investigation is for a sample of 12 industrial countries. In contrast to previ-
ous investigations on the subject, the analysis focuses on a detailed time-series response of the
nominal wage and price using quarterly data. In addition, asymmetry in the cyclical adjust-
ment of the real wage and output is studied over time during expansions and contractions. The
combined evidence in the paper illustrates patterns of the wage–price spiral and accompanying
fluctuations. The evidence supports the following scenarios. During expansions, the simultane-
ous overlap of nominal adjustments in labor and product markets prolongs output expansion
while maintaining or increasing the real standard of living. In contrast, structural and institu-
tional settings appear to have moderated the severity of output contraction and the reduction
1 For more details on this theoretical possibility, see Cover and Van Hoose (2002) and Kandil (2002a, 2002b).
Insider–outsider models attempt an alternative explanation for asymmetric nominal wage adjustments (see, e.g., Blanchard
& Summers, 1988; Lindbeck & Snower, 1986).
2 For more details on this theoretical possibility, see Ball and Mankiw (1994), Caballero and Engel Eduardo (1991),
Caplin and Leahy (1991) and Tsiddon (1991).

214 M. Kandil / Journal of Economics and Business 59 (2007) 212–240
in agents’ real standard of living during economic downturns in many of the countries under
investigation.3
The remainder of the paper is organized as follows. Section 2 provides theoretical background
and literature review. The outline of empirical investigation is presented in Section 3. Section 4
presents the results. Section 5 offers a summary and conclusions.
2. Theoretical background and literature review
To illustrate the dynamics of the wage–price spiral, a theoretical model is briefly outlined
following the detailed framework in Blanchard (1986).4 Conditions in the goods and labor markets
specify the dynamics of the nominal wage and price adjustments to demand shocks.
The output and labor markets are characterized with monopolistic competition. Monopolist
firms compete in setting prices for competitive goods. Moreover, monopolistic unions compete
setting wages for competitive labor. Goods produced by firms are imperfect substitutes. The
demand for each good varies with real money balances and the relative price to the aggregate
price level. The demand for labor varies with the demand for goods. An increase in aggregate
demand generates a larger demand for labor, the faster the reduction in return to scale. The demand
for a specific type of labor varies also negatively with the relative nominal wage. An increase in
the real wage increases the marginal cost of labor, increasing firm’s relative output price.
An increase in real money balances increases aggregate demand.5 Assuming decreasing return
to scale, an increase in aggregate demand increases the output relative price. As the union wants
to supply more labor, its relative nominal wage decreases. An increasing marginal disutility of
work also induces an increase in the union’s relative nominal wage. A decrease in the return to
scale causes a higher relative nominal wage in response to the increased aggregate demand.6
Conditions in labor and product markets are dependent on the staggering of wage and price
adjustments over time. Price setting is staggered over 2 years. Further, wage and price setting
decisions in labor and product markets overlap. The predetermined nominal price is a weighted
average of the optimal price, which depends on the current nominal wage, and on the expected
value of the optimal price, which depends on the expectation of the nominal wage and nominal
money for period t + 1. For each interval during which price is fixed, firms predetermine price
such that the expected average markup is a nondecreasing function of expected average aggregate
demand.
Staggering of the nominal wage over a 2-year period is similar. The nominal wage chosen is
a weighted average of the optimal wage, which depends on past values of the price level and
the money supply, and the expected nominal wage, which is a function of the price and nominal
money expected to prevail. With staggering, the union predetermines the nominal wage such
3 The empirical literature on the cyclical behavior of the real wage can be classified into aggregate and disaggregate
studies. The former includes Bodkin (1969), Cho and Cooley (1990), Cushing (1990), Geary and Kennan (1982), Kandil
(1996), Kandil and Woods (2002), Neftci (1978) and Sumner and Silver (1989). Disaggregate studies include Barsky and
Solon (1989), Bils (1985), Kandil (1999, 2002b), Kandil and Woods (1995, 1997), Keane, Moffit, and Runkle (1988)
and Solon, Barsky, and Parker (1994). For surveys of the empirical evidence, see Abraham and Haltiwanger (1995), and
Kniesner and Goldsmith (1987).
4 For other related references, see Ecreg, Henderson, and Levin (2000) and Holmes and Hutton (1996).
5 Assuming constant velocity, demand disturbances vary with the money supply.
6 The elasticity of the nominal wage and price to a change in aggregate demand is smaller under a constant return to
scale.
that the expected average real wage is a nondecreasing function of expected average aggregate
demand.
With wage and price staggering, the relative flexibility of wage and price determines the
dynamics of the wage–price spiral as follows. At time t = 0, after an increase in the money supply,
for example, firms increase their nominal price only to the extent that they want and can increase
their markup to supply more output. At time t = 1, wages increase because prices are higher and
the demand for labor has increased. Unions increase their nominal wage only to the extent that
they want and can increase their real wage to supply a higher level of labor. As wages become
more flexible, prices adjust again and so on.
The process of wage and price adjustments to change in aggregate demand is well described as
a wage–price spiral. After an increase in demand, attempts by workers and by firms to maintain
or increase real wages (markups) lead to a general increase in nominal wages and prices. The
process continues until wages and prices have risen proportionately to the increase in aggregate
demand and desired real wages, markup and output are all again consistent with full-equilibrium
levels. The slower is the wage–price spiral, the higher the degree of price level inertia and the
slower the process of adjustment towards full-equilibrium.
Provided that workers and firms enjoy a comparable degree of wage and price flexibility,
the real wage oscillates (increasing or decreasing) in its adjustment towards full-equilibrium.
This is because workers attempt, for every interval during which nominal wages are fixed, to
obtain a higher real wage. Firms, on the other hand, also attempt for every interval during which
nominal prices are fixed, to obtain a higher markup. These attempts are consistent because the
two intervals described above do not coincide but overlap; implying the existence of a path of
increases in nominal prices and wages such that the average markup and the average real wage
are higher in turn. Accordingly, this scenario (flexible nominal wages and prices) implies no
persistent deviation of the real wage from its equilibrium value: the real wage simply oscillates
around this value as output returns to equilibrium. According to this scenario, the process of
adjustment under staggering wage and price decisions implies that there be no systematic relation
between real wages and output in response to demand shocks.
Recent research on business cycles has produced evidence that demonstrates the asymmetric
effects of monetary shocks on economic variables. Cover (1992) uses a two-step procedure to
measure positive and negative monetary shocks. Having measured the shocks, they are employed
in a reduced-form equation that tests asymmetry in the effects of these shocks on output growth.
Cover (1992) employs data for the United States.
Kandil (1996) employs the methodology by Cover to separate monetary shocks into positive
and negative components. Shocks are symmetrically distributed around a steady-state trend that
follows agents’ forecasts over time. The forecast equation is estimated jointly with the empirical
models explaining wages, prices, and real output to study asymmetry in the cyclical behavior of the
real wage using quarterly and annual data for the United States in the pre- and post-World War II.
Applying this methodology, the study of asymmetry proceeded in several directions. First,
Kandil (1998) studies the asymmetric effects of nominal GDP shocks, as a proxy for aggregate
demand shocks. The sample of countries includes developing and developed countries. Having
measured asymmetry in the effects of demand shocks on output growth and price inflation, the
paper investigates non-neutrality, as evident by the difference in the effects of positive and negative
shocks over time. Second, Kandil (1999) investigates the stabilizing function of price flexibility
in moderating real output fluctuations with respect to positive and negative demand shocks. More
flexibility of price with respect to positive shocks, relative to negative shocks, would maximize the
stabilizing function of upward price flexibility, relative to downward flexibility. The framework
includes data for a sample of industrial countries in the pre- and post-war periods employing
aggregate demand shocks, as measured by shocks to nominal GDP. Third, Kandil (2001, 2002c)
demonstrate asymmetry in the effects of government spending shocks using quarterly data in the
United States. The evidence differentiates the validity of the Ricardian equivalence and crowding
out with respect to positive and negative shocks to government spending. Finally, Kandil and
Mirzaie (2002) investigate possible asymmetry in the effects of fluctuations in the value of the
dollar, with respect to positive and negative shocks to the exchange rate, on sectoral output and
price in the United States.7
The current investigation extends the analysis of asymmetry to study the dynamics of the
wage–price spiral and its implications on the adjustment of output towards full-equilibrium, as
well as fluctuations in the real standard of living with business cycles. The relative flexibility
of wages and prices over time will determine the output adjustment towards full-equilibrium
and the results on agents’ real standard of living. Adjustments in real variables towards full-
equilibrium will be dependent on the speed of adjustment, as well as the relative flexibility, of
wages and prices. The theoretical background for rigidity and possible asymmetry in the labor
and/or product markets builds on the following theoretical background.
Asymmetric nominal wage flexibility maybe the result of institutional settings that differenti-
ate nominal wage and salary negotiations in the upward and downward directions.8 Alternatively,
asymmetric flexible wages maybe an endogenous response to uncertainty impinging on the eco-
nomic system. Models of the variety of Gray (1978) and Gray and Kandil (1991) have emphasized
the dependency of the degree of wage indexation on the variability of stochastic disturbances.
Higher demand variability may signal future inflationary risks, increasing agents’ incentives for
the upward adjustment of wages. If demand variability is larger for positive shocks, compared to
negative shocks, upward nominal flexibility exceeds downward flexibility. Similarly, in economies
with a history of high trend inflation, agents’ incentives are likely to be larger for upward wage
flexibility, compared to downward flexibility. Accordingly, the countercyclical response of the
real wage may be more pronounced in the face of negative demand shocks compared to positive
shocks, producing a possibility of an increase in the real wage during expansions and contractions.
An alternative explanation of supply-side asymmetry (see, for example, Ball & Mankiw, 1994)
is based on menu costs; the cost and effort involved in changing prices. Inflation causes firms’
relative prices to decline automatically between price adjustments. When a firm wants a lower
relative price (in the face of contractionary demand shocks), inflation does much of the work,
decreasing the need to pay the menu cost. By contrast, an expansionary demand shock, coupled
with high inflation, means that firm’s desired relative price rises while its actual relative price
is falling. As trend price inflation increases, positive shocks are more likely to induce a larger
price adjustment compared to negative shocks. Hence, the procyclical real wage maybe more
pronounced in the face of negative demand shocks compared to positive shocks, producing a
possibility of an increase in the product mark-up during expansions and contractions.
7 Other investigations have analyzed asymmetry using a VAR-based model. Examples include DeLong and Summers
(1988), Karras (1996a, 1996b), Romer and Romer (1989), and Weise (1999), who demonstrate the asymmetric effects of
monetary shocks using annual data for output and, in a few cases, price.
8 During boom periods, cost of living adjustments maybe specified to guarantee workers upward adjustment of wages
to keep up with inflation. In contrast, firms maybe reluctant to take aggressive measures towards adjusting wages in the
downward direction. This is because the search and training cost of hiring new workers to accommodate a future rise in
demand may actually exceed the perceived loss of retaining workers at wages that exceed the marginal physical product
of labor during recessionary periods.
3. Empirical investigation
The data under investigation are for a sample of 12 industrialized countries for which quarterly
data are available. The price level is measured by the consumer price index (CPI) and real output
is measured by industrial production.9 In the countries under investigation, there are different
types of institutions that pertain to wage policy, labor unions, market power, political economy
considerations, among others. The investigation will illustrate the dynamics of the wage/price
spiral and its asymmetry in a diverse set of countries that are subject to distinct institutional and
structural underpinnings.
The period covered is from 1960.I to 2000.IV.10 The first decade was dominated by fixed
exchange rates under the Bretton Woods system. Subsequently, exchange rates have become
flexible in industrial countries. The sample period is also characterized by different monetary
policy choices. Various countries at various times over this period adopted inflation-targeting,
interest rate targeting, and nominal monetary growth rules.11
The empirical investigation will illustrate the dynamics of aggregate demand shocks on price
inflation, nominal wage inflation, real output growth, and real wage growth. Aggregate demand
shocks are measured by the shocks to nominal GNP or GDP. This is a broad measure of aggregate
spending that accounts for a variety of domestic shocks as well as imported shocks into open
economies that have varying effects within countries over time.12 Further, the cross-country
investigation is intended to provide an objective assessment given variation in country size, the
degree of openness, collective bargaining, and labor market institutions which may affect the
response of macro variables to aggregate demand shocks. Hence, the results will prove useful
to draw a general conclusion on the degree of wage flexibility relative to price flexibility and
accompanying effects on the real wage and output over the business cycle.
It is assumed that aggregate economic variables fluctuate in response to aggregate demand
shocks and a major source of supply-side shocks, energy price shocks. Shocks are randomly
distributed over the time span under investigation with a zero mean and a constant variance.
Positive shocks represent unanticipated increase in the growth of aggregate demand above its
anticipated steady-state value. Negative shocks represent unanticipated reduction in the growth of
aggregate demand below its anticipated steady-state value. Detailed econometric methodology is
provided in Appendix A. A detailed description and sources of all data are provided in Appendix B.
The empirical models replicate the reduced-form equations for the nominal wage, the price
level, the real wage, and real output in theory. Demand shifts are separated into anticipated and
unanticipated components. Nominal variables adjust fully to anticipated demand shifts at the
points of setting wages or prices. Accordingly, anticipated demand shifts are likely to determine
9 Quarterly data for real GNP or GDP and its deflator are not available over long time-series span for all countries.
Where available, the results are robust with respect to alternative series for output and price. The effects of nominal GDP
(aggregate demand) shocks, while correlated, are not distributed fully between CPI and industrial production. Hence, it
is necessary to estimate separate equations for output and price.
10 The sample period is based on availability of quarterly data for all variables in different countries at the beginning of
this project.
11 To account for changes in exchange rate regimes, the forecast equation accounts for changes in the exchange rate as
determinants of aggregate demand. Structural dummies are incorporated in the forecast equations where necessary (see
Appendix A). Having incorporated these dummies, there is no evidence of structural break in the estimated reduced-form
equations.
12 The empirical investigation will test theory’s implications using a broad measure of aggregate demand, nominal
GDP. The effects of monetary shocks may be dependent on the stance of monetary policy in different countries, limiting
implications for theoretical hypotheses under investigation.
real output until nominal variables have adjusted fully and the real wage is back to its full-
equilibrium value.13 Further, unanticipated demand shocks are distributed between nominal and
real variables. The allocation is dependent on nominal wage and price rigidity. The slower nominal
wage and/or price adjustment, the longer the duration of the output response to demand shocks.
The relative flexibility of the nominal wage and price determines the real wage adjustment to
demand shocks. To test asymmetry in the dynamics of the wage–price spiral, shocks to aggregate
demand are decomposed into positive and negative components. To complete the specification
of empirical models, variables are assumed to vary in response to anticipated and unanticipated
energy price shifts.14 Accordingly, the empirical models are specified as follows:

x
x
x
Dpt = a0 + a1i Et−i−1 Dnt−i + a2pi post−i + a2ni negt−i
i=0 i=0 i=0

x
x
+ a3i Et−i−1 Dqt−i + a4i Dqst−i + ηpt (1)
i=0 x i=0 x

x
Dwt = b0 + b1i Et−i−1 Dnt−i + b2pi post−i + b2ni negt−i
i=0 i=0 i=0

x
x
+ b3i Et−i−1 Dqt−i + b4i Dqst−i + ηwt (2)
i=0 i=0

x
x
x
D rwt = c0 + c1i Et−i−1 Dnt−i + c2pi post−i + c2ni negt−i
i=0 i=0 i=0

x
x
+ c3i Et−i−1 Dqt−i + c4i Dqst−i + ηrwt (3)
i=0 i=0

x
x
x
Dyt = d0 + d1i Et−i−1 Dnt−i + d2pi post−i + d2ni negt−i
i=0 i=0 i=0

x
x
+ d3i Et−i−1 Dqt−i + d4i Dqst−i + ηyt (4)
i=0 i=0
The log values of the price level, the nominal wage, the real wage, and real output are denoted by
pt , wt , rwt , and yt , respectively. The empirical models are specified in differenced form where D(.)
is the difference operator.15 nt − i denotes the log value of aggregate demand (nominal GNP/GDP)
13 This prediction arises also in a framework that assumes price rigidity only (see, e.g., Ball, Mankiw, & Romer, 1988)
or nominal wage rigidity only (see, e.g., Gray & Kandil, 1991).
14 It is important to account for major sources of supply-side shifts to increase the accuracy of approximating the effects
of demand shifts using nominal GNP or GDP. Quarterly data are not available to measure productivity for various countries
over time.
15 All dependent variables, real output, price, the nominal wage and the real wage, are tested for nonstationarity. The
specification of the test follows the suggestions of Nelson and Plosser (1982). Based on the results of the Dickey–Fuller
test (see, e.g., Dickey & Fuller, 1981), the null hypothesis of nonstationarity is accepted for all dependent variables in
the various countries under investigation. In a few cases, it was necessary to difference the nominal wage and price twice
to render the series stationary. Cointegration test results reject the hypothesis of a common stochastic trend between the
nonstationary dependent variables and nonstationary right-hand side variables (anticipated energy price and aggregate
demand).
at time t − i. Et − i denotes the expectation of a variable at time t − i. post − i and negt − i denote the
positive and negative components of unanticipated growth in aggregate demand conditioned on
information at time t − i − 1. qt − i denotes the log value of the energy price at time t − i. Dqst − i
denotes unanticipated change in the energy price conditioned on information at time t − i − 1.16
Given the interest in detecting dynamics of adjustments over time, the estimates will illustrate
the cumulative effects of the shocks on variables for lag length x = 1, 2, 3, 4, 6, and 8 quarters.17
Accordingly, the evidence will detect the detailed movement of variables in the face of aggregate
demand shocks, over time. To conserve space, the analysis below will focus on these dynamics.
Detailed
results are available upon request.
a2pi and a2ni approximate the inflationary and deflationary effects of demand shocks on
price over time. These are the cumulative effects of the shocks over time, as approximated by
the impulse response function. Negative cumulative effects will indicate
pricerigidity, i.e., price
inflation moves countercyclically to aggregate demand shocks.18 b2pi and b2ni approximate
the inflationary and deflationary effects of demand shocks on the nominal wage over time. The
combined
effects
of expansionary and contractionary
shocks on the real wage are approximated by
c2pi and c2ni . Finally, d2pi and dni approximate the expansionary and contractionary
effects of aggregate demand shocks on real output over time.
4. Estimation results
To estimate the empirical models (1) through (4), empirical proxies are formed to approximate
shocks to aggregate demand and the energy price. Given the interdependence among variables in
the economic system, the empirical models (1) through (4) are estimated jointly with equations
that approximate agents’ forecasts of variables in the empirical models (see Appendix A for
details).
This section summarizes the detailed time-series evidence of the dynamics of aggregate demand
shocks on variables by country. Statistical significance will be established based on the cumulative
response of variables to anticipated aggregate demand shifts, positive and negative demand shocks.
These responses are judged as statistically significant at the 5 or 10% levels.
4.1. Anticipated demand shifts
The cumulative response of variables to anticipated demand shifts indicates the speed of adjust-
ment to full-equilibrium. Given space limitations, this section describes significant adjustments
over time based on estimated parameters.19
In Australia, both nominal wage and price adjust significantly to anticipated demand shifts
with magnitudes that equal 0.65 and 0.56, respectively, in the current period. Anticipated
demand shifts are neutral on real output and the real wage, both in the current and lagged
periods.
16 The energy price is measured by an index of average world crude petroleum price. This index is likely to capture the
combined effects of fluctuations in the international price and the exchange rate on the supply side of the economy.
17 Shocks may have persistent effects if structural and/or institutional constraints interfere with agents’ ability to accom-
modate the shocks.

18 For example, price control measures may be in effect or the effect of supply shocks may be more dominant on price
inflation.
19 Detailed estimates are available upon request.
In Austria, prices appear rigid with respect to anticipated demand shifts. As the nominal
wage appears to be relatively more flexible, the real wage increases significantly with respect to
anticipated demand shifts with a coefficient 0.055 in the current period. The increase in the real
standard of living does not correlate with a significant increase in real output growth.
In Canada, the nominal wage and price adjust significantly to anticipated demand shifts with
magnitudes that equal 0.62 and 0.81, respectively, in the current period. Anticipated demand shifts
are neutral on real output and real wage growth, both in the current and lagged periods.
In Finland, prices appear rigid with respect to anticipated demand shifts. In contrast, both
the nominal and real wage adjust significantly to anticipated demand shifts in the current period
with coefficients 0.13 and 0.14, respectively. Anticipated demand shifts are neutral on real output
growth, both in the current and lagged periods.
In France, all variables adjust significantly to anticipated demand shifts in the current period
with magnitudes 0.47, 1.01, 0.54, and 0.25 for price, the nominal wage, the real wage, and real
output, respectively.
In the Netherlands, both price and the nominal wage adjust positively and significantly to
anticipated demand shifts in the current period with equal magnitudes, 0.31, neutralizing their
effects on the real wage. Nonetheless, output adjusts significantly to anticipated demand shifts
with a magnitude 0.69, in the current period.
In Germany, in contrast to price rigidity, the nominal wage adjusts significantly to anticipated
demand shifts in the current period with a magnitude 0.50, resulting in a significant adjustment
of the real wage that equals 0.62. Concurrently, output increases significantly with respect to
anticipated demand shifts with a magnitude 0.91.
In Italy, both price and the nominal wage adjust significantly to anticipated demand shifts
in the current period with magnitudes 0.51 and 1.017, respectively. As the nominal wage is
more flexible, the real wage adjusts significantly to anticipated demand shifts in the current
period with a magnitude 0.51. Anticipated demand shifts are neutral on real output in the current
period.
In Japan, all variables adjust significantly to anticipated demand shifts, in the current period,
with magnitudes 0.47, 1.013, 0.54, and 0.25 for price, the nominal wage, the real wage, and real
output. As adjustments take place in the current period, variables adjust reasonably fast towards
full-equilibrium in anticipation of aggregate demand shifts.
In Sweden, the speed of adjustment of price and the nominal wage to anticipated demand shifts
is insignificant in the current period. The cumulative adjustment, in the current and lagged quarter,
is significant on the nominal wage and price, neutralizing the effects of these shifts on the real
wage and output.
In the U.K., the nominal wage and price adjust significantly to anticipated demand shifts in
the current period with magnitudes 0.56 and 0.65, respectively. Anticipated demand shifts are
neutral on real output and the real wage in the current period.
In the U.S., anticipated demand shifts are absorbed in price and the nominal wage, in the
current period, with magnitudes 0.65, 0.59, neutralizing their effects on the real wage. Anticipated
demand shifts increase real output growth in the current period with a coefficient 0.56.
4.2. During expansions
Table1 summarizes the cumulative response of dependent variables to expansionary demand

shocks, xi=1 post−i , for i = 0, 1, 2, 3, 4, 6, 8. Statistical significance at each lag length will be
evaluated to infer significant patterns of adjustment over time. Price inflation is evident by the
Table 1
The cumulative effects of expansionary (pos) demand shocks on economic variables
x
Country Dependent The cumulative effect of i=0
post−i
variable
x=0 x=1 x=2 x=3 x=4 x=6 x=8
Dpt 0.13 (0.92) 0.22 (1.00) 0.41 (1.60) 0.37 (1.40) 0.74 (1.35) 0.84* (2.87) 0.98* (3.34)
Dwt 0.40* (2.00) 0.96* (3.50) 0.79* (2.45) 0.66** (1.77) 0.42 (1.10) 0.86** (1.85) 1.11* (2.09)
M. Kandil / Journal of Economics and Business 59 (2007) 212–240

Australia
D rwt 0.26 (1.32) 0.75* (2.54) 0.38 (1.10) 0.29 (0.73) 0.042 (0.094) 0.031 (0.059) 0.0022 (0.0034)
Dyt 0.20 (0.61) 0.52 (1.05) −0.19 (−0.32) 0.034 (0.51) 0.49 (0.69) 0.32 (0.42) −0.27 (−0.32)
Dpt 0.062** (1.70) 0.052 (1.06) 0.043 (0.67) 0.0048 (0.07) 0.026 (0.35) 0.067 (0.79) 0.05 (0.49)
Dwt −0.031 (−0.38) 0.07 (0.63) −0.04 (−0.29) −0.017 (−0.11) −0.09 (−0.38) 0.034 (0.23) −0.01 (−0.038)
Austria
D rwt −0.093 (−1.11) 0.018 (0.15) −0.077 (−0.54) −0.02 (−0.12) −0.12 (−0.62) −0.03 (−0.13) −0.03 (−0.11)
Dyt 0.11 (1.57) 0.19** (1.89) 0.22** (1.76) 0.36* (2.50) 0.34* (2.15) 0.37* (2.02) 0.24* (2.84)
Dpt 0.098 (0.62) 0.25 (1.16) 0.088 (0.36) −0.11 (−0.43) −0.26 (−0.99) 0.053 (0.21) −0.07 (−0.24)
Dwt 0.073 (0.34) −0.07 (−0.24) −0.065 (−0.18) 0.33 (0.83) 0.59 (1.35) 0.37 (0.80) 0.50 (0.98)
Canada
D rwt −0.024 (−0.11) −0.31 (−0.94) −0.30 (−0.74) 0.44 (0.96) 0.84 (1.68) 0.32 (0.58) 0.57 (0.94)
Dyt 0.70* (4.00) 0.53* (2.28) 0.33 (1.21) 0.50** (1.69) 0.44 (1.12) 0.48 (1.34) 0.67 (1.68)
Dpt −0.075 (−1.24) −0.20* (−2.47) −0.23* (−2.33) −0.08 (−0.58) −0.28 (−1.28) −0.18 (−0.99) −0.50* (−1.96)
Dwt 0.15 (1.01) −0.48* (−2.76) −0.31 (−1.44) −0.02 (−0.06) 0.18 (0.17) 0.42 (0.83) 0.095 (0.098)
Finland
D rwt 0.23 (1.63) −0.30** (−1.77) −0.09 (−0.44) 0.04 (0.12) 0.39 (0.97) 0.59 (1.12) 0.38 (0.47)
Dyt 0.35* (2.33) 0.52* (2.48) 0.59* (2.27) 1.25* (3.14) 0.72 (1.55) 1.20* (2.10) 0.41 (0.49)
Dpt 0.049 (0.54) 0.36* (3.96) 0.46* (4.72) 0.47* (4.17) 0.33* (4.34) 0.64* (4.34) 0.55* (3.13)
Dwt 0.24** (1.81) 0.59* (3.86) 0.80* (4.64) 1.11* (6.32) 1.13* (5.82) 1.077* (4.50) 1.19* (4.44)
France
D rwt 0.19** (1.73) 0.23 (1.47) 0.32** (1.74) 0.65* (3.31) 0.58* (2.65) 0.43 (1.57) 0.76* (2.35)
Dyt 1.36* (6.81) 0.99* (3.93) 0.90* (3.24) 0.82* (2.61) 0.72* (2.00) 0.84** (1.89) 0.68 (1.29)
Dpt 0.19 (1.16) 0.17 (0.75) 0.0017 (0.0063) −0.022 (−0.07) 0.18 (0.59) 0.072 (0.17) −0.014 (−0.026)
Dwt 0.089 (0.51) 0.75* (3.53) 0.98* (3.97) 1.04* (3.77) 1.01* (3.29) 1.54* (4.55) 1.37* (3.24)
Germany
D rwt −0.097 (−0.40) 0.59** (1.83) 0.97* (3.36) 1.06* (2.45) 0.82** (1.76) 1.47* (2.49) 1.39 (0.84)
Dyt 0.80* (8.17) 0.65* (4.96) 0.61* (4.11) 0.49* (3.19) 0.45* (2.73) 0.28 (1.29) 0.37 (1.41)
Dpt 0.18 (1.39) 0.41* (2.19) 0.57* (2.21) 0.66* (2.30) 0.70* (2.04) 1.76* (4.29) 1.75* (3.32)
Dwt 0.39** (1.93) 0.33 (1.15) 0.51 (1.31) 0.45 (1.21) −0.12 (−1.08) 0.20 (0.28) 0.49 (0.24)
Italy
D rwt 0.20 (0.87) −0.075 (−0.22) 0.18 (0.39) −0.21 (−0.40) 0.61 (0.17) −1.55* (−2.89) −1.19 (−0.92)
Dyt 0.048 (0.52) 0.30* (2.31) 0.065 (0.42) 0.066 (0.35) −0.06 (−0.22) −0.47** (−1.84) −0.89* (−2.43)
221
222
Table 1 (Continued)
x
post−i
variable
x=0 x=1 x=2 x=3 x=4 x=6 x=8
Dpt 0.013 (0.08) 0.11 (0.50) 0.17 (1.44) 0.0093 (0.029) −0.17 (−0.40) −0.088 (−0.21) −0.18 (−0.37)
Dwt 0.0098 (0.04) 0.12 (0.34) 0.74** (1.70) 0.62 (1.15) 0.40 (0.69) 1.38* (2.073) 1.16 (1.48)
Japan

D rwt −0.003 (−0.01) 0.019 (0.053) 0.62 (1.36) 0.62 (1.11) 0.003 (0.89) 1.47* (3.30) 1.34** (1.85)
Dyt 1.17* (7.01) 1.09* (4.81) 1.15* (3.82) 1.32* (3.62) 1.48* (4.46) 1.65* (3.21) 1.68* (2.79)
Dpt 0.18* (1.96) 0.15 (1.15) −0.22 (−1.32) 0.0004 (0.002) 0.052 (0.21) 0.068 (0.23) −0.12 (−0.34)
Dwt −0.069 (−0.42) 0.35 (1.60) 0.004 (0.015) 0.014 (0.45) −0.19 (−0.48) 0.22 (0.41) −0.048 (−0.076)
Netherlands
D rwt −0.25 (−1.56) −0.05 (−0.23) −0.12 (−0.45) 0.14 (0.46) −0.16 (−0.40) 0.15 (0.50) 0.087 (0.24)
Dyt 0.82* (8.78) 0.85* (6.49) 0.85* (5.09) 0.99* (4.98) 1.04* (4.29) 0.92** (1.78) 1.15* (2.11)
Dpt 0.019 (0.75) 0.11* (3.14) 0.16* (3.32) 0.16 (1.21) 0.13 (0.78) −0.23 (−0.94) −0.28 (−0.79)
Dwt −0.017 (−0.23) 0.26* (2.31) 0.58* (4.84) 0.88* (2.95) 0.58 (1.57) 0.21 (0.32) −0.77 (−0.93)
Sweden
D rwt −0.036 (−0.48) 0.13 (1.12) 0.40* (3.02) 0.62 (1.64) 0.43 (0.89) 0.44 (0.65) −0.57 (−0.58)
Dyt 0.027 (0.42) −0.044 (−0.43) −0.12 (−0.86) 0.002 (0.005) −0.18 (−0.30) 0.40 (0.41) 2.067 (1.32)
Dpt 0.42* (2.62) 0.70* (3.51) 0.75* (3.06) 0.89* (3.22) 0.95* (3.05) 0.49 (1.18) 1.076* (2.20)
Dwt 0.27** (1.88) 0.67* (3.45) 0.52* (2.28) 0.57* (2.16) 0.51 (1.59) 0.78** (1.75) 0.90 (1.39)
United Kingdom
D rwt −0.15 (−0.83) −0.034 (−0.13) −0.22 (−0.69) −0.33 (−0.92) −0.47 (−1.11) 0.28 (0.49) −0.18 (−0.25)
Dyt 0.78* (5.97) 0.60* (4.08) 0.48* (2.70) 0.53* (2.75) 0.50* (2.29) 0.77* (2.64) 0.64** (1.82)
Dpt 0.29* (1.97) 0.41* (2.11) 0.41** (1.84) 0.30 (1.18) 0.13 (0.44) −0.44 (−1.30) −0.29 (−0.72)
Dwt 0.48* (3.85) 0.59* (3.23) 0.97* (4.23) 1.22* (4.55) 1.31* (4.48) 1.063* (2.74) 0.91* (2.10)
United States
D rwt 0.19 (1.34) 0.18 (0.85) 0.55* (1.99) 0.93* (2.64) 1.15* (2.77) 1.50* (3.15) 1.21* (2.16)
Dyt 0.56* (4.95) 0.46* (2.85) 0.25 (1.27) 0.24 (0.82) 0.22 (0.92) 0.58* (1.95) 0.68** (1.78)
Notes: x x x x x
Dpt = a0 + i=0 a1i Et−i−1 Dnt−i + i=0 a2pi post−i + i=0 a2ni negt−i + i=0 a3i Et−i−1 Dqt−i + i=0 a4i Dqst−i + ηpt ,
x x x x x
Dwt = b0 + i=0 b1i Et−i−1 Dnt−i + i=0 b2pi post−i + i=0 b2ni negt−i + i=0 b3i Et−i−1 Dqt−i + i=0 b4i Dqst−i + ηwt ,
x x x x x
D rwt = c0 + i=0 c1i Et−i−1 Dnt−i + i=0 c2pi post−i + i=0 c2ni negt−i + i=0 c3i Et−i−1 Dqt−i + i=0 c4i Dqst−i + ηrwt ,
x x x x x
Dyt = d0 + d E
i=0 1i t−i−1
Dnt−i + d post−i +
i=0 2pi
d negt−i +
i=0 2ni
d E
i=0 3i t−i−1
Dqt−i + d Dqst−i + ηyt .
i=0 4i
Coefficients measure the cumulative response of variables to expansionary and contractionary demand shocks at various lag lengths, x. t-Ratios are in parentheses. * and **
denote statistical significance at the 5 and 10% levels, respectively.
positive and significant response of price to expansionary demand shocks. Cumulative negative
response indicates rigidity of price inflation in the face of expansionary demand shocks. Judged
by the cumulative response, price inflation is persistent in the face of expansionary demand shocks
in Australia, France, Italy, Sweden, the United Kingdom, and the United States.
Nominal wage inflation appears significant and persistent in the face of expansionary demand
shocks in Australia, France, Germany, Japan, Sweden, the United Kingdom, and the United States.
Nominal wage flexibility exceeds price flexibility, increasing real wage growth in the face
of expansionary demand shocks in Australia, France, Germany, Japan, Sweden, and the United
States (judged by statistical significance at varying lag lengths). The evidence of a significant
reduction in real wage growth in the face of expansionary demand shocks is limited to Finland
and Italy. For the remaining countries, the dynamics of the wage–price spiral has insulated real
wage growth from significant fluctuations in the face of expansionary demand shocks. That is,
nominal wage inflation and price inflation adjust closely in the face of expansionary demand
shocks, neutralizing the effects of these shocks on the real wage.
Output expansion appears significant and persistent in the face of expansionary demand shocks
in Austria, Canada, Finland, France, Germany, Japan, the Netherlands, the United Kingdom, and
the United States.
4.3. During contractions
Table2 summarizes the cumulative response of dependent variables to contractionary demand

shocks, xi=0 negt−i , for x = 0, 1, 2, 3, 4, 6, 8. Price deflation is evident by the positive and
significant response of price to contractionary demand shocks. Cumulative negative response
indicates rigidity of price deflation in the face of contractionary demand shocks. Judged by the
cumulative positive response, price deflation appears significant and persistent in the face of
contractionary demand shocks in France, Italy, the Netherlands, and Sweden (judged by statistical
significance at varying lag lengths).
Nominal wage deflation is significant and persistent in the face of contractionary demand
shocks in Australia, France, Germany, the Netherlands, and Sweden.
Nominal wage flexibility exceeds price flexibility, decreasing real wage growth in the face of
contractionary demand shocks in France, the Netherlands and Sweden. In the remaining countries,
nominal wage and price inflation adjust closely in the face of contractionary demand shocks, neu-
tralizing the effects of these shocks on real wage growth. The negative and statistically significant
cumulative response of the real wage for Italy (x = 6) indicates an increase in the real wage during
contractions. That is, price deflation is not correlated with a comparable wage deflation in the
face of contractionary demand shocks.
Output fluctuations appear significant and persistent in the face of contractionary demand
shocks in Canada, Germany, Italy, Japan, the Netherlands, and the United States.
Figs. 1–4 contrast the cumulative responses of variables to aggregate demand shocks during
expansions and contractions.
4.4. The wage–price spiral: summary and implications
The combined evidence in Tables 1 and 2 illustrates some asymmetry in real wage adjustment
to expansionary and contractionary demand shocks. To formalize the evidence, Table 3 presents
the difference in the cumulative response of real wage growth to expansionary and contractionary
demand shocks at varying lag lengths, x = 0, 1, 2, 3, 4, 6, 8. Where the evidence is statistically
224
Table 2
The cumulative effects of contractionary (neg) demand shocks on economic variables
x
negt−i
variable
x=0 x=1 x=2 x=3 x=4 x=6 x=8
Dpt 0.092 (0.57) 0.072 (0.30) 0.11 (0.36) 0.092 (0.17) 0.30 (0.76) 0.58 (1.32) 0.52 (1.12)
Dwt −0.17 (−0.79) −0.061 (−0.21) 0.39 (1.025) 0.44 (0.94) 0.63 (1.18) 1.19** (1.70) 0.62 (0.74)
Australia
−0.27 (−1.20) −0.14 (−0.44)

D rwt 0.31 (0.77) 0.34 (0.69) 0.35 (0.58) 0.67 (0.84) 0.16 (0.16)
Dyt 0.028 (0.08) 0.31 (0.58) 0.54 (0.79) 0.15 (0.18) −0.24 (−0.25) −0.14 (−0.12) −0.17 (−0.12)
Dpt −0.04 (−1.12) −0.05 (−0.95) −0.02 (−0.26) 0.057 (0.49) 0.12 (0.97) 0.21 (1.40) 0.28 (1.19)
Dwt 0.0096 (0.12) 0.11 (0.92) 0.14 (0.81) 0.25 (0.91) 0.11 (0.02) 0.39 (1.19) 0.54 (0.84)
Austria
D rwt 0.05 (0.60) 0.16 (1.28) 0.17 (0.94) 0.20 (0.55) −0.0092 (−0.023) 0.18 (0.44) 0.13 (0.20)
Dyt −0.12 (−1.61) −0.28* (−2.59) −0.35* (−2.22) −0.21 (−0.85) −0.46** (−1.89) −0.75* (−2.75) −0.91** (−1.72)
Dpt 0.09 (0.56) 0.09 (0.41) −0.059 (−0.24) −0.51** (−1.95) −0.52** (−1.88) −0.19 (−0.63) 0.0018 (0.004)
Dwt 0.094 (0.43) 0.25 (0.83) 0.19 (0.52) −0.17 (−0.41) −0.19 (−0.53) 0.28 (0.51) 0.92 (1.29)
Canada
D rwt 0.004 (0.02) 0.15 (0.45) 0.37 (0.91) 0.37 (0.78) 0.31 (0.58) 0.47 (0.72) 0.92 (1.083)
Dyt 0.82* (4.58) 0.71* (3.01) 1.01* (3.74) 0.92* (2.96) 0.65** (1.87) 0.45 (1.057) 0.11 (0.20)
Dpt 0.037 (0.76) −0.026 (−0.37) 0.013 (0.14) 0.19 (1.26) 0.13 (0.75) 0.12 (0.61) −0.17 (−0.63)
Dwt −0.10 (−0.82) −0.023 (−0.15) −0.06 (−0.29) 0.32 (0.88) 0.76 (0.95) 0.60 (1.10) 0.38 (0.46)
Finland
D rwt −0.14 (−1.20) 0.014 (0.095) −0.07 (−0.35) 0.12 (0.33) 0.61 (1.41) 0.74 (1.24) 0.67 (0.78)
Dyt −0.25* (−2.05) −0.49* (−2.67) −0.26 (−1.03) 0.85* (1.99) 0.14 (0.28) 0.64 (0.99) 0.27 (0.31)
Dpt 0.098 (1.12) 0.48* (4.52) 0.54* (4.49) 0.54* (3.84) 0.50* (3.21) 0.65* (3.14) 0.77* (2.97)
Dwt −0.13 (−1.04) 0.37* (2.07) 0.78* (3.76) 1.06* (4.80) 1.07* (4.43) 0.95* (2.80) 1.20* (3.11)
France
D rwt −0.23* (−2.14) −0.095 (−0.52) 0.19 (0.84) 0.52* (2.12) 0.57* (2.09) 0.13 (0.34) 0.55 (1.21)
Dyt 1.37 (1.28) 0.76 (0.81) 0.44 (0.58) 0.32 (1.29) 0.26 (0.13) 0.79 (1.29) 0.095 (0.13)
Dpt −0.062 (−0.37) −0.014 (−0.06) 0.17 (0.57) 0.19 (0.19) 0.093 (0.33) 0.27 (0.37) 0.28 (0.28)
Dwt 0.063 (0.33) 0.12 (0.56) 0.37 (1.34) 0.28 (0.36) 0.34 (0.79) 1.052** (1.82) 0.57 (0.73)
Germany
D rwt 0.12 (0.50) 0.14 (0.41) 0.20 (0.47) 0.088 (0.16) 0.23 (0.50) 0.78 (0.77) 0.26 (0.19)
Dyt 0.90* (8.89) 0.78* (5.86) 0.59* (3.53) 0.30 (1.54) 0.044 (0.18) 0.15 (0.41) −0.41 (−0.85)
Dpt 0.035 (0.22) 0.18 (0.74) 0.42 (1.23) 0.89* (2.27) 0.87** (1.78) 2.11* (3.51) 1.96* (2.39)
Dwt 0.15 (0.61) 0.22 (0.59) 0.41 (0.79) 0.20 (0.32) −0.64 (−0.19) −0.27 (−0.25) 0.97 (0.58)
Italy
D rwt 0.11 (0.41) 0.037 (0.084) 0.061 (0.10) −0.69 (−0.95) 0.25 (0.70) −2.38* (−2.27) −0.79 (−0.39)
Dyt 0.32* (2.84) 0.36* (2.14) 0.19 (0.92) 0.08 (0.31) −0.034 (−0.11) −0.40 (−1.069) −1.08** (−1.88)
Table 2 (Continued )
x
negt−i
variable
x=0 x=1 x=2 x=3 x=4 x=6 x=8
Dpt 0.092 (0.51) 0.17 (0.72) −0.11 (−0.37) 0.16 (0.46) 0.35 (0.85) 0.31 (0.53) 0.066 (0.076)
Dwt 0.44 (1.48) 0.60 (1.58) −0.086 (−0.19) 0.19 (0.33) 0.49 (0.72) −0.17 (−0.18) −0.75 (−0.53)
Japan

D rwt 0.35 (1.22) 0.43 (1.11) −0.045 (−0.094) −0.033 (−0.054) 0.13 (0.082) −0.48 (−1.11) −0.82 (−0.63)
Dyt 0.46* (2.49) 0.48* (1.95) 0.48 (1.51) 0.069 (0.18) −0.13 (−0.27) −0.68 (−0.94) −1.11 (−1.018)
Dpt 0.089 (0.87) 0.18 (1.33) 0.23 (1.36) 0.38* (1.96) 0.29 (1.30) 0.22 (0.91) 0.18 (0.69)
Dwt 0.22 (1.19) 0.10 (0.44) 0.48** (1.79) 0.48 (1.57) 0.52 (1.49) 0.83** (1.92) 0.77 (1.65)
Netherlands
D rwt 0.13 (0.71) −0.081 (−0.36) 0.21 (0.78) 0.16 (0.54) 0.22 (0.64) 0.61* (2.51) 0.58* (2.22)
Dyt 0.91* (8.85) 0.82* (6.07) 0.78* (4.60) 0.68* (3.50) 0.68* (3.18) 0.78** (1.89) 0.80** (1.81)
Dpt −0.28 (−0.97) 0.06 (1.45) 0.097** (1.81) 0.10 (0.69) 0.015 (0.08) −0.35 (−1.28) −0.40 (−1.05)
Dwt 0.10 (1.13) 0.27* (1.99) 0.64* (4.11) 1.021* (2.57) 0.60 (1.45) 0.23 (0.32) −0.93 (−0.99)
Sweden
D rwt 0.12 (1.38) 0.19 (1.36) 0.50* (3.35) 0.79** (1.85) 0.55 (1.00) 0.56 (0.69) −0.65 (−0.62)
Dyt −0.0045 (−0.06) −0.096 (−0.78) −0.15 (−0.96) −0.13 (−0.26) −0.25 (−0.37) 0.42 (0.39) 2.17 (1.29)
Dpt −0.43** (−1.74) 0.13 (0.43) 0.19 (0.50) 0.33 (0.76) 0.21 (0.38) 0.43 (0.86) 0.24 (0.43)
Dwt −0.18 (−0.84) 0.064 (0.21) 0.14 (0.39) −0.051 (−0.12) −0.04 (−0.087) −0.48 (−1.01) −0.27 (−0.64)
United Kingdom
D rwt 0.24 (0.88) −0.07 (−0.17) −0.013 (−0.026) −0.38 (−0.68) −0.22 (−0.35) −0.91 (−1.32) −0.47 (−0.58)
Dyt 0.64* (3.22) 0.18 (0.80) 0.28 (1.02) −0.37 (−1.23) −0.0066 (−0.021) 0.02 (0.057) 0.11 (0.27)
Dpt −0.054 (−0.30) −0.11 (−0.48) −0.53* (−2.21) −0.60* (−2.46) −0.48 (−1.54) 0.31 (1.06) 0.25 (0.68)
Dwt −0.04 (−0.26) −0.16 (−0.75) −0.42** (−1.71) −0.52* (−2.05) −0.57* (−2.11) −0.30 (−0.90) 0.21 (0.53)
United States
D rwt 0.013 (0.07) −0.052 (−0.21) 0.11 (0.37) 0.08 (0.24) −0.19 (−0.52) −0.61 (−1.41) −0.045 (−0.088)
Dyt 1.11* (7.89) 1.22* (6.34) 1.58* (7.51) 1.70* (7.98) 1.65* (7.39) 1.42* (5.50) 1.09* (3.29)
Notes: x x x x x
Dpt = a0 + i=0 a1i Et−i−1 Dnt−i + i=0 a2pi post−i + i=0 a2ni negt−i + i=0 a3i Et−i−1 Dqt−i + i=0 a4i Dqst−i + ηpt ,
x x x x x
Dwt = b0 + i=0 b1i Et−i−1 Dnt−i + i=0 b2pi post−i + i=0 b2ni negt−i + i=0 b3i Et−i−1 Dqt−i + i=0 b4i Dqst−i + ηwt ,
x x x x x
x x x x x
Dyt = d0 + d E
i=0 1i t−i−1
Dnt−i + d post−i +
i=0 2pi
d negt−i +
i=0 2ni
d E
i=0 3i t−i−1
Dqt−i + d Dqst−i + ηyt .
i=0 4i
Coefficients measure the cumulative response of variables to expansionary and contractionary demand shocks at various lag lengths, x. t-Ratios are in parentheses. * and **
denote statistical significance at the 5 and 10% levels, respectively.
225
Fig. 1. Graphs for price inflation.
significant, the increase in real wage growth during expansions appears pronouncedly larger com-
pared to the reduction during contractions in Australia (x = 0, 1), Finland (x = 0), France (x = 0, 1),
Germany (x = 2, 3), Japan (x = 6, 8), the United Kingdom (x = 6), and the United States (x = 3–8).
Asymmetry may indicate a higher degree of monopoly power in the labor market compared to
the output market. Therefore, nominal wage inflation exceeds price inflation during expansions.
In contrast, the relative adjustment of wages and prices does not reveal comparable reduction
of the real wage during contractions. Further, there is no evidence of a larger reduction in real
wage growth during contractions compared to its increase during expansions in any country.
The remaining evidence indicates symmetry in real wage adjustment to expansionary and con-
tractionary demand shocks, i.e., comparable degree of monopoly power in labor and product
markets in many countries. That is, institutional and structural conditions do not pronouncedly
Fig. 2. Graphs for wage inflation.
differentiate incentives for relative adjustments of wage and price in the face of expansionary and
contractionary demand shocks.
Table 3 also presents the difference in the cumulative response of output growth to expansion-
ary and contractionary demand shocks at varying lag lengths. Where the evidence is statistically
significant, the increase in output growth during expansions appears pronouncedly larger com-
pared to the reduction during contractions in Austria (x = 0–4, 6, 8), Finland (x = 0–2), Germany
(x = 4, 8), Japan (x = 0–4, 6, 8), and the United Kingdom (x = 1, 3, 4, 6). The decrease in real output
growth during contractions appears pronouncedly larger compared to the increase during expan-
sions in Canada (x = 2), Italy (x = 0), and the United States (x = 0–4, 6). Overall, output fluctuations
appear longer-lasting during expansions compared to contractions in the majority of countries.
Fig. 3. Graphs for real wage growth.
To shed additional light on patterns of asymmetry in Table 3, consider correlations between

significant fluctuations in real output and the real wage. During expansions (see Table 1), the
increase in real wage growth correlates with an increase in output growth in France, Ger-
many, Japan, and the United States. In Australia, France, and Sweden, the increase in real wage
growth does not correlate with a significant increase in output growth during expansions. In con-
trast, the increase in output growth does not correlate with a significant increase in real wage
growth during expansions in Austria, Canada, Finland, Italy, the Netherlands, and the United
Kingdom.
During contractions (see Table 2), the reduction in real output growth does not correlate
with a significant reduction in real wage growth in Canada, Finland, Germany, Italy, Japan,
Fig. 4. Graphs for output growth.
the Netherlands, the United Kingdom, and the United States. The close adjustments of wages
and prices (where these adjustments are significant) have protected workers’ real standard of
living in the face of contractionary demand shocks in the majority of countries under investiga-
tion.
In general, the real wage adjustment to expansionary and contractionary demand shocks indi-
cates that the wage–price spiral does not present serious challenge to workers’ real standard of
living in the sample of countries under investigation. The slow adjustment of wages and prices
has resulted in persistent expansionary and contractionary effects on real output growth in many
countries. These persistent effects do not correlate with systematic reduction of the real wage in
230
Table 3
Asymmetry in real wage and output adjustments to expansionary and contractionary demand shocks
x=0 x=1 x=2 x=3 x=4 x=6 x=8
Australia
D rwt 0.53* (2.69) 0.89* (3.014) 0.07 (0.20) −0.05 (−0.13) −0.31 (−0.69) −0.64 (−1.22) −0.16 (−0.24)
Dyt 0.17 (0.52) 0.21 (0.42) −0.73 (−1.23) −0.12 (−0.17) 0.73 (1.028) 0.46 (0.60) −0.10 (−0.12)

Austria
D rwt −0.14** (−1.71) −0.14 (−1.18) −0.25** (−1.73) −0.22 (−1.32) −0.11 (−0.58) −0.21 (−0.91) −0.16 (−0.59)
Dyt 0.23* (3.28) 0.47* (4.68) 0.57* (4.56) 0.57* (3.96) 0.80* (5.06) 1.12* (6.10) 1.15* (13.61)
Canada
D rwt −0.028 (−0.13) −0.46 (−1.39) −0.67** (−1.65) 0.07 (0.15) 0.53 (1.06) −0.15 (−0.27) −0.35 (−0.58)
Dyt −0.12 (−0.69) −0.18 (−0.77) −0.68* (−2.49) −0.42 (−1.40) −0.21 (−0.85) 0.03 (0.084) 0.56 (1.40)
Finland
D rwt 0.37* (2.62) −0.31* (−1.85) −0.02 (−0.097) −0.08 (−0.24) −0.22 (−0.55) −0.15 (−0.28) −0.29 (−0.36)
Dyt 0.60* (3.99) 1.01* (4.82) 0.85* (3.27) 0.40 (1.00) 0.58 (1.25) 0.56 (0.98) 0.14 (0.17)
France
D rwt 0.42* (3.82) 0.33* (2.077) 0.13 (0.71) 0.13 (0.66) 0.01 (0.046) 0.30 (1.095) 0.21 (0.65)
Dyt −0.01 (−0.05) 0.23 (0.91) 0.46 (1.66) 0.50 (1.59) 0.46 (1.28) 0.05 (0.11) 0.59 (1.11)
Germany
D rwt −0.22 (−0.89) 0.46 (1.41) 0.77* (2.67) 0.97* (2.25) 0.59 (1.27) 0.69 (1.17) 1.13 (0.68)
Dyt −0.10 (−1.02) −0.13 (−0.99) 0.02 (0.13) 0.19 (1.24) 0.41* (2.46) 0.13 (0.60) 0.78* (2.97)
Italy
D rwt 0.09 (0.39) −0.11 (−0.33) 0.12 (0.26) 0.48 (0.91) 0.36 (0.82) 0.83 (1.55) −0.40 (−0.31)
Dyt −0.27* (−2.95) −0.06 (−0.46) −0.13 (−0.81) −0.014 (−0.074) −0.026 (−0.12) −0.07 (−0.27) 0.19 (0.52)
Japan
D rwt −0.35 (−1.18) −0.41 (−1.15) 0.66 (1.46) 0.65 (1.17) 0.43 (0.68) 1.95* (4.37) 2.16* (2.98)
Dyt 0.71* (4.25) 0.61* (2.69) 0.67* (2.23) 1.25* (3.43) 1.61* (4.85) 2.33* (4.53) 2.79* (4.63)
Netherlands
D rwt −0.38* (−2.37) 0.031 (0.14) −0.33 (−1.24) −0.02 (−0.066) −0.38 (−0.95) −0.46 (−1.53) −0.49 (−1.36)
Dyt −0.09 (−0.96) 0.03 (0.23) 0.07 (0.42) 0.31 (1.56) 0.36 (1.49) 0.14 (0.27) 0.35 (0.64)
Table 3 (Continued )
x=0 x=1 x=2 x=3 x=4 x=6 x=8
Sweden
D rwt −0.16* (−2.08) −0.06 (−0.52) −0.10 (−0.76) −0.17 (−0.45) −0.12 (−0.25) −0.12 (−0.18) 0.08 (0.08)
Dyt 0.032 (0.49) 0.052 (0.51) 0.03 (0.22) 0.13 (0.33) 0.07 (0.14) −0.02 (−0.02) −0.10 (−0.066)
United Kingdom
D rwt −0.39* (−2.16) 0.036 (0.14) −0.21 (−0.65) 0.05 (0.14) −0.25 (−0.59) 1.19* (2.08) 0.29 (0.40)
Dyt 0.14 (1.07) 0.42* (2.86) 0.20 (1.13) 0.90* (4.67) 0.51* (2.32) 0.75* (2.51) 0.53 (1.51)
United States
D rwt 0.18 (1.25) 0.23 (1.096) 0.44 (1.59) 0.85* (2.43) 1.34* (3.23) 2.11* (4.43) 1.26* (2.24)
Dyt −0.55* (−4.86) −0.76* (−4.71) −1.33* (−6.76) −1.46* (−4.99) −1.43* (−5.98) −0.84* (−2.82) −0.41 (−1.07)
Notes: x x x x x
x x x x x
Dyt = d0 + d E Dnt−i + d post−i + d negt−i + d E Dqt−i + d Dqst−i + ηyt .
i=0 1i t−i−1 i=0 2pi i=0 2ni i=0 3i t−i−1
x
i=0 4i x
Coefficients indicate the difference in the cumulative response of real wage growth, (c − c2ni ), or output growth,
i=0 2pi
(d − d2ni ), to expansionary and contractionary
i=0 2pi
demand shocks at various lag length x. t-Ratios are in parentheses. * and ** denote statistical significance at the 5 and 10% levels, respectively.
231
Fig. 5. Asymmetric effects of demand shocks.
the majority of countries. The implication is that wage and price adjustments overlap simultane-
ously over time. More importantly, workers were able to secure higher and faster adjustments of
the nominal wage that dominate that of price during expansions in a few countries.
Fig. 5 illustrates asymmetry in the response of real wage growth and output growth to aggregate
demand shocks during expansions and contractions.
5. Summary and conclusion
This investigation has focused on the dynamics of nominal wage and price adjustments in
the face of aggregate demand shocks. The spill-over effects of nominal adjustments across labor
and product markets are commonly known as the wage–price spiral. The spill-over dynamics are
likely to vary with conditions in labor and product markets of various economies. Further, these
conditions may differentiate the dynamics of adjustments within a given economy in the face of
positive and negative demand shocks.
The empirical investigation analyzes quarterly data for a sample of 12 industrial countries.
For each of the countries, an empirical time-series model is estimated. The results indicate the
dynamics of wage and price adjustments in the face of expansionary and contractionary demand
shocks. To complete the evidence, empirical models are also estimated to measure the effects
of expansionary and contractionary demand shocks on the growth of real output and the real
wage.
The evidence is consistent with slow adjustments of nominal wages and prices in the face
of demand shocks. Consistently, demand shocks have persistent effects on real output in several
countries. Interestingly, these persistent effects are not correlated with systematic fluctuations in
the real wage in the face of demand shocks in many countries. Overall, comparable adjustments
in labor and product markets have insulated real wage growth from significant fluctuations in the
face of demand shocks. Where fluctuations in the real wage appear significant, the evidence is
consistent with an increase in real wage growth in the face of expansionary demand shocks in
several countries. In contrast, the evidence supports a significant reduction in real wage growth
during contractions in a fewer number of the countries under investigation.
In summary, the evidence for a sample of 12 industrial countries indicates that the wage–price
spiral neutralizes, or may even improve, workers’ real standard of living in the face of demand
shocks. In addition, significant output fluctuations appear longer-lasting during expansions com-
pared with contractions in the majority of countries.
The paper’s evidence clearly illustrates the function of the wage–price spiral as workers attempt
to maintain their real wages and firms aspire to secure their profit markup – the battle of the
markups – in the face of demand shocks. During expansions, the simultaneous overlap of nom-
inal adjustments in labor and product markets prolongs output expansion while maintaining or
increasing the real standard of living. During contractions, the disadvantages of the wage–price
spiral (or lack of spiral) appear limited in prolonging output contraction or decreasing agents’ real
standard of living. Structural and institutional settings appear to have moderated the severity of
contractionary demand shocks on real output growth and the real standard of living in the variety
of countries under investigation.
For policy implications, variation in the evidence across countries should alert policy
makers to the necessary adjustments (both institutional and structural) that would maximize the
positive effects of business cycles during expansions and minimize their adverse effects during
contractions.
Acknowledgements
The views expressed in this paper are those of the author and should not be interpreted as those
of the International Monetary Fund. The author thanks two anonymous referees for valuable
comments on an earlier draft.
Appendix A. Econometric methodology
The surprise terms that enter models (1) through (3) are unobservable, necessitating the con-
struction of empirical proxies before estimation can take place. Thus, the empirical models include
equations describing agents’ forecast of aggregate demand growth and the change in energy price.
Table A1
Detailed estimates using four lags: The Price Equation
Shocks A1 A2 C F1 F2 G I J N S U1 U2
post 0.17 0.039 0.14 −0.049 0.18* 0.10 0.30* −0.0017 0.16** 0.019 0.13 0.14
(1.25) (1.09) (1.09) (−0.76) (2.03) (0.56) (2.02) (−0.01) (1.76) (0.39) (0.92) (1.33)
post−1 0.15 0.0018 0.082 −0.0081 0.11 −0.021 0.052 0.085 0.0069 0.051 0.31* −0.0012
(1.14) (0.05) (0.60) (−0.12) (1.06) (−0.11) (0.30) (0.50) (0.07) (0.99) (2.08) (−0.01)
post−2 0.11 −0.028 −0.14 0.0035 0.15 −0.15 0.26 −0.12 0.034 0.026 −0.0032 0.012
(0.77) (−0.77) (−1.03) (0.06) (1.50) (−0.79) (1.50) (−0.68) (0.37) (0.54) (−0.02) (0.10)
post−3 −0.021 0.0012 −0.093 −0.062 −0.024 0.068 0.0066 0.014 −0.13 −0.047 0.17 0.023
(−0.15) (0.03) (−0.72) (−1.07) (−0.24) (0.37) (0.03) (0.08) (−1.42) (−0.85) (1.16) (0.19)
post−4 −0.014 0.013 −0.25** −0.099** 0.13** 0.18 0.086 −0.13 −0.081** 0.081 0.35* −0.045
(−0.10) (0.35) (−1.87) (−1.79) (1.72) (0.92) (0.53) (−0.74) (−0.84) (1.76) (2.16) (−0.36)
negt 0.11 0.054 −0.097 0.022 0.038 −0.065 0.25 0.082 0.049 −0.0051 0.0043 0.036
(0.73) (1.08) (−0.77) (0.39) (0.63) (−0.34) (1.22) (0.44) (0.49) (−0.10) (0.02) (0.27)
negt−1 −0.067 −0.0087 −0.071 −0.042 0.25* 0.048 0.36 0.22 0.034 0.054 0.36 0.039
(−0.44) (−0.21) (−0.54) (−0.81) (2.64) (0.26) (1.67) (1.18) (0.33) (0.92) (1.63) (0.29)
negt−2 −0.018 0.04 −0.17 0.049 0.085 0.13 −0.057 −0.38* −0.011 −0.026 0.14 −0.37*
(−0.12) (0.92) (−1.25) (0.89) (0.89) (0.64) (−0.25) (−1.99) (−0.11) (−0.43) (0.63) (−2.91)
negt−3 0.099 0.0097 −0.26* 0.06 0.10 −0.17 0.35 0.17 0.13 0.037 0.039 −0.11
(0.66) (0.23) (−1.97) (1.02) (1.06) (−0.81) (1.68) (0.90) (1.25) (0.65) (0.17) (−0.86)
negt−4 0.18 0.024 0.077 0.042 0.031 0.15 −0.036 0.26 0.07 −0.045 −0.37 −0.007
(1.18) (0.51) (0.54) (0.63) (0.32) (0.74) (−0.20) (1.34) (0.66) (−0.91) (−1.57) (−0.05)
Country codes are as follows: A1: Australia, A2: Austria, C: Canada, F1: Finland, F2: France, G: Germany, I: Italy, J: Japan, N: Netherlands,
S: Sweden, U1: United Kingdom, U2: United States.
Empirical Model:

x

x

x

x

x
Dpt = a0 + a1i Et−i−1 Dnt−i + a2pi post−i + a2ni negt−i + a3i Et−i−1 Dqt−i + a4i Dqst−i + ηpt .
i=0 i=0 i=0 i=0 i=0
t-ratios are in parantheses.
The predictive values from this equation are the proxies for agents’ expectations of the change in
aggregate demand and the energy price.
Obtaining a proxy for agents’ forecast of nominal GDP growth is complicated by the maintained
hypothesis that the level of nominal GDP is endogenous, which is supported by the results of the
test suggested by Engle (1982). Anticipated aggregate demand growth is generated by taking
the fitted values of a reduced-form equation for the change in the log value of nominal GNP
or GDP in which the explanatory variables include lagged values of the change in theoretical
determinants of aggregate demand, as follows: four lags of the change in the short-term interest
rate and four lags of the change in the log value of real output, the price level, the energy price,
government spending, the money supply, and the exchange rate. Surprises that enter the empirical
models are then formed by subtracting agents’ forecasts from the actual growth in nominal GDP
or GNP.
The energy price is exogenous according to the results of the test suggested in Engle (1982).
Obtaining a proxy for ex-ante forecasts of the energy price is complicated by the assumption that
the generating process experienced a structural change between 1973 and 1974. This assumption
is supported by the results of a formal test suggested in Dufour (1982). For both the period
1960.I–1973.IV and the period 1974.I–2000.IV, the generating process is modeled as a fourth-
Table A2
Detailed estimates using four lags: The Nominal Wage Equation
post 0.48* −0.03 0.083 0.062 0.47* 0.085 −0.012 −0.03 0.023 0.14 0.13 0.32*
(2.49) (−0.34) (0.41) (0.40) (3.44) (0.50) (−0.05) (−0.12) (0.16) (1.08) (0.84) (2.87)
post−1 0.46* 0.075 −0.17 −0.065 0.34* 0.60* −0.30 0.12 0.28** 0.29* 0.34* 0.25*
(2.40) (0.83) (−0.77) (−0.42) (2.19) (3.43) (−0.93) (0.47) (1.84) (2.11) (2.22) (2.03)
post−2 −0.14 −0.12 −0.065 0.29* 0.21 0.23 −0.12 0.50** −0.17 0.098 −0.022 0.35*
(−0.71) (−1.32) (−0.31) (2.06) (1.36) (1.33) (−0.37) (1.81) (−1.12) (0.77) (−0.14) (2.77)
post−3 −0.13 0.015 0.51* −0.063 0.15 0.18 0.28 −0.079 −0.037 −0.12 0.039 0.24**
(−0.68) (0.16) (2.51) (−0.47) (0.96) (1.07) (0.81) (−0.29) (−0.24) (−0.78) (0.26) (1.90)
post−4 −0.25 −0.03 0.23 −0.045 −0.045 −0.087 0.036 −0.11 −0.29** 0.17 0.022 0.15
(−1.22) (−0.34) (1.09) (−0.34) (−0.39) (−0.47) (0.12) (−0.39) (−1.82) (1.35) (0.13) (1.16)
negt −0.22 0.11 0.06 −0.03 −0.23* 0.082 0.043 0.41 0.08 0.03 0.11 0.005
(−1.04) (0.89) (0.30) (−0.23) (−2.43) (0.47) (0.12) (1.38) (0.49) (0.22) (0.51) (0.04)
negt−1 0.23 0.064 0.096 0.10 0.43* 0.0022 −0.37 0.33 −0.05 0.30** 0.12 −0.20
(1.08) (0.63) (0.46) (0.83) (2.91) (0.01) (−0.92) (1.11) (−0.30) (1.85) (0.51) (−1.40)
negt−2 0.38** 0.049 −0.20 0.10 0.49* 0.33** 0.19 −0.57** 0.18 0.21 0.039 −0.17
(1.78) (0.46) (−0.94) (0.91) (3.31) (1.77) (0.48) (−1.88) (1.09) (1.31) (0.17) (−1.33)
negt−3 0.11 −0.015 −0.10 0.24** 0.41* −0.11 −0.49 0.23 0.19 0.081 −0.28 −0.04
(0.52) (−0.14) (−0.48) (1.71) (2.72) (−0.59) (−1.25) (0.76) (1.08) (0.54) (−1.21) (−0.31)
negt−4 0.13 −0.094 −0.047 0.35* −0.027 0.039 −0.017 0.092 0.12 −0.025 −0.037 −0.17
(0.61) (−0.80) (−0.21) (2.10) (−0.18) (0.20) (−0.05) (0.30) (0.68) (−0.19) (−0.15) (−1.25)
S: Sweden, U1: United Kingdom, U2: United States. Empirical Model:

x

x

x

x

x
Dwt = b0 + b1i Et−i−1 Dnt−i + b2pi post−i + b2ni negt−i + b3i Et−i−1 Dqt−i + b4i Dqst−i + ηwt .
i=0 i=0 i=0 i=0 i=0
order autoregressive process. The proxy for energy price surprises is then formed by subtracting
these forecasts from the actual change in the energy price.
Where test results also support structural break in the aggregate demand equation, dummy
variables are included in the forecast equations. Upon accounting for these dummy vari-
ables, testing for structural break in the estimated empirical models proved to be insignifi-
cant.
Surprises that enter the empirical models are then formed by subtracting agents’ forecasts
from the actual growth in each variable. Shocks are purely random, i.e., i.i.d., and orthogonal to
variables in the information set. These shocks, as well as detailed parameter estimates from the
forecast equations, are available upon request. Given concerns about the “generated regressors”
problem and in order to obtain efficient estimates and ensure correct inferences (i.e., to obtain
consistent variance estimates), the empirical models are estimated jointly with the equation that
determines the proxy variables following the suggestions of Pagan (1984, 1986). To account for
the endogeneity of demand variables, instrumental variables are used in the estimation of the
empirical models. The instrument list includes four lags of the change in the interest rate and four
lags of the change in the log value of real output, the price level, government spending, the money
supply, and the exchange rate, as well as the change in current and four lags of the log value of
the energy price.
Table A3
Detailed estimates using four lags: The Real Wage Equation
post 0.31 −0.069 −0.064 0.11 0.29** −0.018 0.29 −0.033 −0.13 0.11 −0.015 0.16
(1.49) (−0.74) (−0.26) (0.69) (1.90) (−0.07) (1.23) (−0.12) (−0.88) (0.80) (−0.08) (1.03)
post−1 0.32 0.073 −0.25 −0.061 0.23 0.61* −0.21 0.042 0.27** 0.24 0.027 0.24
(1.54) (0.76) (−0.95) (−0.38) (1.32) (2.29) (−0.77) (0.15) (1.80) (1.60) (0.13) (1.43)
post−2 −0.24 −0.091 0.075 0.28** 0.065 0.37 0.19 0.062 −0.20 0.068 −0.021 0.32
(−1.13) (−0.95) (0.29) (1.87) (0.38) (1.41) (0.69) (0.15) (−1.38) (0.50) (−0.10) (1.88)
post−3 −0.12 0.013 0.60* −0.0033 0.17 0.12 0.21 −0.093 0.11 −0.074 −0.13 0.25
(−0.58) (0.14) (2.42) (−0.02) (0.95) (0.45) (0.690) (−0.32) (0.70) (−0.47) (−0.66) (1.41)
post−4 −0.23 −0.042 0.49** 0.072 −0.18 −0.27 0.13 0.025 −0.20 0.087 −0.33 0.20
(−1.01) (−0.45) (1.90) (0.51) (−1.34) (−0.94) (0.49) (0.08) (−1.32) (0.65) (−1.49) (1.13)
negt −0.32 0.054 0.146 −0.06 −0.26* 0.15 0.29 0.33 0.017 0.022 0.11 −0.0.16
(−1.43) (0.41) (0.61) (−0.43) (−2.52) (0.54) (0.90) (1.07) (0.11) (0.15) (0.38) (−0.09)
negt−1 0.28 0.073 0.16 0.14 0.18 −0.049 0.047 0.10 −0.076 0.23 −0.24 −0.24
(1.23) (0.67) (0.64) (1.08) (1.10) (−0.18) (0.14) (0.33) (−0.46) (1.36) (−0.79) (−1.25)
negt−2 0.42** 0.0088 −0.03 0.067 0.41* 0.20 0.084 −0.20 0.19 0.23 −0.10 0.22
(1.79) (0.08) (−0.12) (0.50) (2.41) (0.71) (0.24) (−0.61) (1.15) (1.32) (−0.34) (1.21)
negt−3 0.0081 −0.025 0.14 0.17 0.31** 0.048 −0.12 0.071 0.049 0.037 −0.32 0.061
(0.04) (−0.22) (0.57) (1.20) (1.82) (0.16) (−0.37) (0.22) (0.29) (0.23) (−1.04) (0.34)
negt−4 −0.039 −0.12 −0.11 0.29 −0.061 −0.11 −0.054 −0.18 0.042 0.024 0.33 −0.21
(−0.17) (−0.94) (−0.40) (1.67) (−0.36) (−0.38) (−0.19) (−0.55) (0.25) (0.17) (1.01) (−1.11)

x

x

x

x

x
Drwt = c0 + c1i Et−i−1 Dnt−i + c2pi post−i + c2ni negt−i + c3i Et−i−1 Dqt−i + c4i Dqst−i + ηrwt .
i=0 i=0 i=0 i=0 i=0
To test for the asymmetric effects of positive and negative aggregate demand shocks, the
positive and negative components of aggregate demand shocks are defined as follows:
negt = − 21 {abs(Dnst ) − Dnst }, post = 21 {abs(Dnst ) + Dnst }
abs(.) is the absolute value operator. Dnst is the shock to the growth of nominal GDP at time
t, and negt and post are the negative and positive components of the shocks, respectively. The
mathematical definitions of these components follow the suggestions of Cover (1992) to facilitate
joint estimation.
Following the suggestions of Engle (1982), the results of the test for serial correlation in simul-
taneous equation models are consistent with the presence of fourth-order autoregressive errors in
some models. To maintain comparability (a standard assumption in cross-country investigations),
it is assumed in all models that the error term follows an AR(4) process. To filter out serial cor-
relation, the estimated model is transformed through the filter (1 − ρ1 L1 − ρ2 L2 − ρ3 L3 − ρ4 L4 )
where ρi are the estimates of the serial correlation parameters and Li are the lag operators such
that Li Xt = Xt − i . The estimated residuals from the transformed models have zero means and are
serially independent.
The paper’s qualitative evidence remains robust in a number of exercises that include varying
the lag length and variables in the information and the instruments list, varying the specification
Table A4
Detailed estimates using four lags: The Output Equation
post 0.51 0.083 0.66* 0.63* 0.99* 0.87* 0.064 1.11* 0.86* 0.056 1.06* 0.69*
(1.57) (1.11) (4.13) (3.44) (3.87) (9.30) (0.66) (5.96) (9.33) (0.32) (10.32) (7.94)
post−1 −0.008 0.17* −0.03 0.30 −0.11 −0.074 0.24* −0.036 −0.014 −0.062 −0.25 −0.06
(−0.03) (2.15) (−0.17) (1.64) (−0.38) (−0.78) (2.18) (−0.19) (−0.15) (−0.35) (−4.42) (−0.62)
post−2 −0.99* −0.018 −0.19 0.039 −0.029 −0.039 −0.39* 0.15 −0.038 −0.15 −0.14 −0.19*
(−2.91) (−0.23) (−1.16) (0.23) (−0.10) (−0.41) (−3.66) (0.74) (−0.41) (−0.87) (−1.36) (−1.97)
post−3 0.34 0.051 0.056 −0.18 −0.029 −0.19* 0.17 0.18 0.16 0.13 0.0084 −0.15
(1.02) (0.67) (0.35) (−1.08) (−0.010) (−1.99) (1.59) (0.90) (1.66) (0.65) (0.08) (−1.53)
post−4 0.64** 0.055 −0.061 −0.075 −0.095 −0.12 −0.14 0.095 0.083 −0.15 −0.18 −0.054
(1.88) (0.73) (−0.36) (−0.47) (−0.44) (−1.16) (−1.31) (0.47) (0.86) (−0.93) (−1.59) (−0.53)
negt −0.27 0.049 0.89* 0.29* 1.55* 0.82* 0.39* 0.47* 0.92* 0.061 0.28** 1.01
(−0.74) (0.46) (5.73) (1.82) (8.94) (8.45) (2.94) (2.31) (9.24) (0.34) (1.87) (1.19)
negt−1 0.26 −0.21* −0.09 −0.035 −0.44 −0.18* −0.25** −0.091 −0.016 −0.12 −0.33* 0.15
(0.72) (−2.38) (−0.55) (−0.24) (−1.57) (−1.91) (−1.80) (−0.43) (−0.16) (−0.58) (−2.09) (1.33)
negt−2 0.28 −0.023 0.22 0.27** −0.47** −0.18* 0.12 0.038 0.003 0.042 0.15 0.29*
(0.74) (−0.26) (1.29) (1.74) (−1.69) (−1.74) (0.89) (0.18) (0.03) (0.20) (0.98) (2.82)
negt−3 −0.27 0.01 −0.16 0.31** −0.17 −027* −0.29* −0.42* −0.15 −0.22 −0.18 0.18**
(−0.74) (0.11) (−0.98) (1.84) (−0.60) (−2.59) (−2.08) (−2.00) (−1.36) (−1.13) (−1.14) (1.79)
negt−4 −0.24 −0.29* −0.21 −0.68* −0.21 −0.14 −0.014 −0.14 −0.079 −0.0095 0.067 0.023
(−0.64) (−2.89) (−1.17) (−3.41) (−0.76) (−1.32) (−0.12) (−0.63) (−0.75) (−0.05) (0.40) (0.22)

x

x

x

x

x
Dyt = d0 + d1i Et−i−1 Dnt−i + d2pi post−i + d2ni negt−i + d3i Et−i−1 Dqt−i + d4i Dqst−i + ηyt .
i=0 i=0 i=0 i=0 i=0
of the final models, and using a two-step estimation procedure. Details of these exercises, as well
as all diagnostic tests, are available upon request.
Appendix B. Data sources
1. Real output: Index of industrial output. Generally, the coverage of this index comprises min-
ing, quarrying, manufacturing, electricity, gas, and water according to the UN International
Standard Industrial Classification (ISIC).
2. Price level: The consumer price index.
3. Nominal wage: Index of the wage rate per worker employed in the industrial sector per specified
time period.
4. Money stock: The sum of currency outside banks and private sector demand deposits.
5. Short-term interest rate: Representatives of short-term market rates for the various countries,
i.e., rates at which short-term borrowing is effected between financial institutions or rates at
which short-term government paper is issued or traded in the market.
6. Government spending: Nominal values of all payments by government.
7. Aggregate demand: Nominal values of GNP/GDP.

8. The energy price: Index of average world crude petroleum price.
9. Real exchange rate: The real price of the domestic currency in terms of currency of major
trading partners.
Sources: All data, except for the exchange rate, are taken from International Financial Statis-
tics. Real exchange rate is from the World Economic Outlook data bank. Both sources are from
the International Monetary Fund, Washington, DC. The qualitative results remain robust in an
experiment in which data are adjusted using a seasonality filter.
End notes
Detailed coefficient estimates are provided in the appendix (Tables A1–A4) for the model
estimation with lag length x = 4.
Statistical significance is established by calculating the t-statistic for the asymmetry coefficient.
The difference between the cumulative coefficients for positive and negative shocks is divided by
the standard deviation of the difference.
The lack of a correlation between real wages and output has been documented by several other
papers, as has the asymmetric response been documented for a subset of countries (see survey by
Abraham & Haltiwanger, 1995).
The pattern of asymmetry, procyclical during expansions and acyclical during contraction
challenges the implications of both sticky-wage and sticky-price models of business cycles. In the
context of sticky-wage models, the real wage decreases during expansions and increases during
contractions. Asymmetry is expected to be consistent with a larger increase in the real wage during
contractions. In the context, of sticky-price models, the real wage increases during expansions
and decreases during contractions. Asymmetry is likely to render the reduction in the real wage
more pronounced during contractions.
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The Wage-Price Spiral International

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Journal of Economics and Business 59 (2007) 212–240

The wage–price spiral: International

JEL classiﬁcation: E30; E31; E32

Keywords: Wage; Price; Spiral

∗ Tel.: +1 202 623 4696; fax: +1 202 589 4696.

Caplin and Leahy (1991) and Tsiddon (1991).

2. Theoretical background and literature review

4.1. Anticipated demand shifts

modate the shocks.

4.2. During expansions

Table1 summarizes the cumulative response of dependent variables to expansionary demand

M. Kandil / Journal of Economics and Business 59 (2007) 212–240

M. Kandil / Journal of Economics and Business 59 (2007) 212–240

4.3. During contractions

Table2 summarizes the cumulative response of dependent variables to contractionary demand

4.4. The wage–price spiral: summary and implications

M. Kandil / Journal of Economics and Business 59 (2007) 212–240

M. Kandil / Journal of Economics and Business 59 (2007) 212–240

Fig. 1. Graphs for price inflation.

Fig. 2. Graphs for wage inflation.

Fig. 3. Graphs for real wage growth.

To shed additional light on patterns of asymmetry in Table 3, consider correlations between

Fig. 4. Graphs for output growth.

M. Kandil / Journal of Economics and Business 59 (2007) 212–240

Fig. 5. Asymmetric effects of demand shocks.

5. Summary and conclusion

Appendix A. Econometric methodology

t-ratios are in parantheses.

t-ratios are in parantheses.

t-ratios are in parantheses.

t-ratios are in parantheses.

Appendix B. Data sources

7. Aggregate demand: Nominal values of GNP/GDP.

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