Demand shocks, supply shocks and the cyclicality of real wages

The behaviour of real wages over the business cycle has received increasing attention in recent years. The cyclicality of real wages constitutes an important aspect of recent models of the business cycle. However, empirical studies undertaken to determine whether real wages are procyclical or countercyclical have reported conflicting findings. In this paper we use vector-autoregressions to analyse the cyclicality of real wages. We find that the source of the disturbance plays a decisive role in the cyclical behaviour of real wages. In particular, we demonstrate that a supply shock generates procyclical real wages, whereas a demand shock yields countercyclicality.