Demand shift across US industries and the stabilizing function of nominal wage and price flexibility
Nominal wage and price adjustments in response to demand shocks are likely to determine industrial output variability. The direction of this relationship is complicated, however, by demand and supply factors. The empirical investigation across a sample of private industries in the United States produces the following evidence. Price flexibility moderates the response of the output supplied to a given shift in industrial demand. Similarly, nominal wage flexibility moderates, although insignificantly, the output response to a given shift in industrial demand. The size of industrial demand shifts dominates, however, supply-side constraints in differentiating output fluctuations across industries. While price flexibility moderates shifts in industrial demand in response to aggregate demand shocks, these shifts are larger the higher the nominal wage flexibility across industries. The combined supply and demand effects differentiate the stabilizing function of nominal wage and price flexibility. Nominal wage flexibility increases output fluctuations in response to aggregate demand shocks. In contrast, output fluctuations are smaller the larger the price adjustment to demand shocks across industries. Given the endogeneity of price flexibility, it is necessary to control for variation in demand variability in order to reveal the stabilizing effect of price flexibility on output across industries.