Monetary innovations, capital taxation, and real wage movements: some new evidence.

• Author: Mohammadi, Hassan

1. Introduction

   Central to many new classical macroeconomic models is the notion that unanticipated money growth affects real wages adversely while anticipated money growth is neutral. To date, however, the empirical evidence on the subject has been mixed. Early studies of Sargent and Sims |29~ and Sims |30~ reported that monetary surprises had a positive effect on real wages. Leiderman |18~, however, provided evidence consistent with the implications of these models. The results of more recent studies have also been ambiguous. Koray |16~ concludes that anticipated money growth has an adverse effect on total real wages but unanticipated money growth is neutral. In contrast, Kim |15~ finds that both anticipated and unanticipated money growth have negative effects on real wages.

   One difficulty with these studies is the implicit assumption that real wage movements are primarily caused by aggregate demand disturbances. In a recent paper, Sumner and Silver |33~ assert that real shocks can also have an important influence on real wages and should be taken into account.(1)

   The primary objective of this paper is to re-examine the response of real wages to economic fundamentals within the context of natural-rate new classical equilibrium and contracting models. This paper differs from the existing literature in that we develop a more sophisticated specification for the natural rate component of real wages. Specifically, we model the natural rate in terms of three supply-side disturbances: real energy prices, sector-specific disturbances, and federal policies toward the taxation of capital.

   Oil price and sectoral disturbances have previously been incorporated into several studies of output and employment determination. A number of studies have shown that changes in real oil prices have a significant effect on output and employment |10; 11; 23~, the level of manufacturing real wages |18; 33~, and total real wages |16~. It has also been demonstrated that sector-specific disturbances will have adverse effects on economic activity even within the context of flexible-price rational expectations models |19; 4~.(2)

   We are not aware of any empirical study that acknowledges an explicit role for capital taxation in determining real wages. However, recent simulation studies have demonstrated that, under plausible assumptions about production technology and wage elasticity of labor supply, replacing a tax on capital income with an equal-revenue-yielding tax on either labor or consumption will substantially accelerate the rate of capital accumulation |2; 13; 21; 32~. This implies that the effective tax rate on capital may have considerable influence on the natural rate component of real wages.

   This work differs from the existing literature in two other ways. First, we assess the relative importance of real versus monetary disturbances in explaining real wage behavior. Second, we apply our model to both annual and quarterly data over the 1955-89 period. The more recent time period is especially important for assessing the role of supply-side factors since (i) real oil prices declined precipitously only after 1986 and (ii) federal government policies towards taxation of capital underwent several significant changes during the 1980s.(3)

   Our empirical results suggest that once we account for the influence of real shocks, the behavior of real wages is not inconsistent with the predictions of the simple natural-rate macro-models. More specifically, anticipated money growth is neutral while unanticipated money growth has a negative effect on real wages. However, monetary shocks can explain only a small portion of the movements in real wages. Most of the real wage movements over the last twenty years are attributable to supply shocks, especially to changes in federal government policies towards the taxation of capital and changes in real oil prices.

   The remainder of this paper is organized as follows. Section II develops the empirical specification of the real wage model. Section III specifies the money growth equation and decomposes money growth into anticipated and unanticipated components. Section IV discusses econometric issues, data, and empirical results. Section V reports the results of simulating the model and section VI contains our summary and conclusions.

2. The Model

   The wage equation formulated in this study is in the tradition of the new classical rational expectations equilibrium |20~ and contracting |8; 9~ models. The deviation of the real wage from its natural level is expressed in terms of a finite distributed lag of one-step-ahead errors in predicting money growth,

   |Mathematical Expression Omitted~,

   where |w.sub.t~ and |Mathematical Expression Omitted~ are logarithms of the actual and natural real wage at time t and |m.sub.t~ and |Mathematical Expression Omitted~ are the actual and anticipated one-step-ahead growth in money supply. We assume that expectations are rational and equal to the conditional forecast of |m.sub.t~ given information available at time t - 1; that is |Mathematical Expression Omitted~. Finally, ||Epsilon~.sub.1t~ is a zero mean (possibly serially correlated) error.

   Traditionally, the natural component of real wages has been modeled as a deterministic trend. For example, Leiderman |18~, Koray |16~, and Sumner and Silver |33~ account for the movement in the natural rate using a time trend and a proxy for real oil price shocks. This approach to modeling the natural rate is problematic on at least two grounds. First, several factors in addition to oil shocks may exert a significant effect on the natural levels of economic activity |7~. Second, there is substantial evidence that natural real wages are best approximated by a stochastic model |26; 31~.(4)

   We address these problems by allowing three real factors--capital taxation, real oil prices, and sector-specific disturbances--to affect the natural level of real wages and by modeling real wages as a nonstationary stochastic process. The remainder of this section explains the construction of the three supply-side variables and our approach to modelling the nonstationarity in the real wage series.

   Capital Taxation

   Measuring the effective tax rate on capital is an inherently difficult task |32~. We proxy this variable by a measure of the effective federal tax rate on corporate income. This measure, |TK.sub.t~, is constructed from national income accounts data following the methodology of Amerkhail, Spooner, and Sunley |1~.(5) That is,

   |TK.sub.t~ = (|CT.sub.t~ - |FRP.sub.t~)/(|CP.sub.t~ - |PFRB.sub.t~), (2)

   where CT is corporate profit tax accruals, FRP is Federal Reserve payments, CP is corporate profits with inventory valuation and capital consumption adjustment, and PFRB is profits of the Federal Reserve banks. This measure accounts for the influence of inflation as well as statutory changes in corporate income tax laws.(6)

   Real Oil Prices

   In constructing an index of oil prices we adopt the procedure suggested by Mork |23~ of supplementing data on the producer price of crude oil with data on refiner...