Managing Labor under Monetary Instability

Experimental Evidence on Wage and Effort Inertia

Abstract

In a controlled laboratory experiment, we study the impact of monetary instability on work relationships with incomplete contracts. We observe wage inertia, i.e. the reluctance to fully adjust nominal wages to the changes in the value of the currency, and effort inertia, i.e. the reluctance to fully adjust the work effort to the alterations of the real wages. Under inflation, these effects lead to cheaper labor and a shift of payoff shares to employers. Under deflation, we observe a higher cost of labor and a shift of payoff shares to employees. Additionally, inflation and deflation lower productivity and per capita earnings.