Policy Shocks and Wage Rigidities: Empirical Evidence from Regional Effects of National Shocks

De Ridder, M. and Pfajfar, D.

This paper studies the effect of wage rigidities on the transmission of fiscal and monetary policy shocks. We calculate downward wage rigidities across U.S. states using the Current Population Survey. These estimates are used to explain differences in the state-level economic effects of identical national shocks in interest rates and taxes. In line with the role of sticky wages in New Keynesian models, we find that contractionary monetary policy and tax shocks increase unemployment and decrease economic activity in rigid states considerably more than in flexible states. We also find larger and more persistent effects of monetary and tax policy shocks for states where the ratio between minimum and median wage is higher and for states that do not have right-to-work legislation.