If Wages Fell During a Recession

Abstract

Many economies exhibit downward wage rigidity. Surveys of managers indicate that employers hold wages rigid because they believe morale will suffer after a wage cut. Otherwise, there is little evidence for how employers beliefs contribute to wage rigidity and whether those beliefs are accurate. Our design allows us to compare beliefs and effort rigorously. We demonstrate that effort falls after workers experience a wage cut and also that workers form reference points from wage contracts. Despite this partial confirmation of the morale theory as an explanation for wage rigidity, half of the employers in our experiment cut wages and lose money as a result. In a treatment where a recession is offset by nominal inflation, real wage cuts do not have a significant effect on effort.