Centro de Políticas Sociais

Labor Markets Adaptation to Inflation and Household Financial Behavior: Lessons From The Brazilian Case¹

This monograph studies the adaptation of labor markets to high inflation and the effects of this adaptation process on household financial behavior. The recent Brazilian experience is used in the empirical analysis. The objective is to evaluate how the combination of high inflation and tight labor market regulation affected payment practices in Brazil over 1980s and early 1990s. I study the evolution of two specific aspects of payments practices: nominal wage adjustment patterns and the frequency of wage payments.

The second objective of the thesis is to assess the impact of changes of labor market arrangements on household financial behavior. Specifically, I will examine two specific aspects of financial decision-making: a) Payment Periods and the Demand for Monetary Aggregates; b) Wage Indexation and the Short-Run Savings Behavior. A key issue modeled here are possible links between shifts in payment practices and breaks in financial assets’ demand.

Besides an introduction, the monograph consists of four central chapters:

A)  The Payments Period and the Demand for Broad Money

B)  Sources of Payments Practices Rigidity

C)  Inflation, Regulation and Wage Adjustments Patterns: Non-Parametric Evidence from Longitudinal Data

D)  Inflation, Wage Indexation and the Permanent Income Hypothesis

[1] I would like to thank my thesis advisor David Card, my second reader Ben Bernanke and my Master degree advisor Angus Deaton for invaluable comments provided.

Why study the recent Brazilian experience?

The answer to this question hinges on two issues: institutional characteristics and data availability. The Brazilian case economy has experienced high inflation for a long time so labor and financial markets institutions and decision-makers that interact in these markets have had the incentives and the time to adapt to such environment.

Simultaneously, high inflationary volatility and associated institutional changes generated a lot of variability to explain. Many of these institutional changes occurred in an abrupt way due to the launching of unsuccessful stabilization policies. These experiences offer us a good laboratory to test different models of labor and financial markets’ adaptation to inflation.

The Brazilian case also provides a rich source of data to test these models. First, there are a variety of micro data sets that include large cross-section surveys and rotating panels of individual workers, as well as series of surveys on consumer finances and consumer expenditures. Second, as opposed to most inflationary experiences, the Brazilian economy presents a widespread use of regulated assets as narrow money substitutes. I will also generate monthly estimates for the distribution of wage payment frequencies from PME (Pesquisa Mensal do Emprego) household surveys. This means that it is possible to test monetary effects of labor markets’ adaptation to inflation using monthly time series. Perhaps more important, the longitudinal aspect of PME data allows us to identify wage adjustment patterns and changes in payment practices of individuals over extended periods of time.

The four central chapters of the monograph are briefly described below:

The Payment Period and the Demand for Broad Money

The first chapter assesses the impact of changes in the frequency of wage payments (e.g. monthly, weekly and so on) on the demand for different monetary aggregates (M1, M4 and so on). It aggregates information on the distribution of payment frequencies into a time series of the average payment period. The purpose of this exercise is to introduce the average payments period variable explicitly into conventional narrow and broad money demand equations. The chapter has two main messages. The payments period variable does not belong to a narrow money demand equation but it belongs to a broad money demand equation. This is in accordance with the transaction motives theory,  however transaction demand motives are clearly insufficient to explain the results found here.

Sources of Payments Practices Rigidity

The second chapter studies the joint determination of payment practices between firms and employees (i. e. wage payment frequencies and wage payment dates) during high inflation. The framework developed in the chapter incorporates the following sources of payment practices rigidities: a) interaction between optimal payment period decisions and portfolio decisions of firms and employees; b) the occurrence of Pareto inefficiencies in the bargaining process between firms and employees due to wage regulation; c) the imposition of nominal wage floors that are invariant to the payment date chosen; d) integer restrictions on payment frequencies. The empirical part of the paper assesses the relevance of these sources of rigidity in payments practices using Brazilian micro data.

Inflation, Regulation and Wage Adjustments Patterns: Non-parametric Evidence from Longitudinal Data

The third chapter gives a first step toward developing a methodology to quantify the effects of inflation and government regulation on short-run earnings dynamics. It also provides evidence on the patterns of wage adjustment adopted during the recent Brazilian experience.

The large variety of official wage indexation rules adopted in Brazil during the past two decades combined with the availability of monthly surveys on labor market outcomes makes the Brazilian case a good laboratory to test how regulation affects earnings dynamics. In particular, the combination of large sample sizes with the possibility of following the same worker for short periods of time makes it possible to estimate the cross-sectional distribution of longitudinal statistics on actual earnings behavior (i. e. monthly and annual rates of change). The plot of the cross-sectional distributions of these longitudinal statistics generated from actual and artificial earnings data provides visual evidence on the impact of inflation and regulation on wage adjustment patterns.

The empirical strategy adopted here is to compare the distributions of longitudinal statistics extracted from actual earnings data with simulations generated from minimum adjustments requirements imposed by the Brazilian Wage Law. The analysis provides a series of measures of the extend to which Brazilian Wage Law Regulations impose biding constraints. The visual analysis of the distribution of wage adjustments is also useful in highlighting stylized facts that may lend to future empirical work.

Inflation, Wage Indexation and the PIH (Permanent Income Hypothesis)

The last chapter of the thesis studies the effects of inflation and wage indexation on the short run savings behavior of household units. It sets an intertemporal utility optimization framework where individuals face high inflation and a system of wage indexation that restores real earnings values in fixed time intervals. Since no borrowing is allowed, the interaction between the declining path of real earnings between wage adjustments and a standard consumption smoothing process generates a high frequency savings stock. Although this savings stock is expected to be relatively modest (up to one-half of aggregate monthly earnings), it is extremely sensitive to changes in the frequency of wage adjustments.

The main testable result is a demand function for assets that is decreasing with frequency of wage adjustments and increasing with the inflation rates. The paper argues that the recent Brazilian experience presents special features that allow us to estimate this asset demand equation. The key explanatory variable is a description of the Brazilian Wage Law from 1964 to 1989. Furthermore, the four changes in the frequency of wage adjustments that occurred in this period offer an opportunity to analyze the effects of observable switches in the regime of wage indexation (i. e. the micro earnings process) on savings decisions of household units.