Identifying Inflation’s Grease and Sand Effects in the Labor Market

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Staff Reports

Identifying Inflation's Grease and Sand Effects in the Labor Market

October 1997 Number 31

JEL classification: C23, E31, J31

Authors: Erica L. Groshen and Mark E. Schweitzer

Inflation has been accused of causing distortionary prices and wage fluctuations (sand) as well as lauded for facilitating adjustments to shocks when wages are rigid downwards (grease). This paper investigates whether these two effects can be distinguished from each other in a labor market by the following identification strategy: inflation-induced deviations among employer's mean wage-changes represent unintended intramarket distortions (sand), while inflation-induced, inter-occupational wage-changes reflect intended alignments with intermarket forces (grease).

Using a unique 40-year panel of wage changes made by large mid-western employers, we find a wide variety of evidence to support the identification strategy. We also find some indications that occupational wages in large firms gained flexibility in the past four years. These results strongly support other findings that grease and sand effects exist, but also suggest that they offset each other in a welfare sense and in unemployment effects. Thus, at levels up to five percent, the net impact of inflation is beneficial but statistically indistinguishable from zero. It turns detrimental after that. When positive, net benefits never exceed a tenth of gross benefits.

Available only in PDF PDF

51 pages / 213 kb

For a published version of this report, see Erica Groshen and Mark E. Schweitzer, "Identifying Inflation's Grease and Sand Effects in the Labor Market," in Martin Feldstein, eds., The Costs and Benefits of Price Stability. Chicago: University of Chicago Press: 273-308.

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