Modeling the time-series behavior of the aggregate wage rate

This paper looks at the time-series behavior of the real wage relative to that of productivity. Given an exogenous, nonstationary process for productivity, we use a simple model of dynamic labor demand to show that the real wage and the marginal product of labor will be cointegrated if the representative firm chooses the profit-maximizing level of employment. Data for the postwar period satisfy this condition. On the basis of this result we estimate a vector error correction model containing prices, wages, and productivity and examine the dynamic relationships among these variables. This specification provides a natural setting for looking at a number of issues of interest, including the role of the unemployment rate in the wage rate equation, issues of wage-price causality, and the effect of exogenous wage rate changes on productivity.