Why Are Nominal Wages Downwardly Rigid, but Less So in Japan? An Explanation Based on Behavioral Economics and Labor Market/Macroeconomic Differences Sachiko Kuroda and Isamu Yamamoto In this paper, we survey the theoretical and empirical literature to investi- gate why nominal wages can be downwardly rigid. Looking back from the 19th century until recently, we first examine the existence and extent of downward nominal wage rigidity (DNWR) for several countries. We find that (1) nominal wages were flexible in the 19th century and the first half of the 20th century, but (2) nominal wages were downwardly rigid in almost all the industrialized countries in the second half of the 20th century, although (3) the extent of DNWR varied from country to country. Next, we use a behavioral economics framework to explain the reasons for DNWR. We also explain why the existence and extent of DNWR varied between time periods and/or from country to country, focusing on differences in the labor market characteristics (such as labor mobility and employment protection legislation) and in the macroeconomic environment (such as economic growth and inflation), which can alter employees’ and firms’ perceptions toward nominal wage cuts. Keywords: Downward nominal wage rigidity; Behavioral economics; Labor mobility; Employment protection legislation; Inflation rate; Indexation JEL Classification: E50, J30, N30, Z13 Sachiko Kuroda: Associate Professor, Hitotsubashi University (E-mail:
[email protected]) Isamu Yamamoto: Associate Professor, Keio University (E-mail:
[email protected]) The authors would like to thank Professors Steinar Holden (University of Oslo) and Fumio Ohtake (Osaka University), the participants at the third modern economic policy research conference, and the staff at the Institute for Monetary and Economic Studies, the Bank of Japan (BOJ), for their valuable comments.