Tsukuba Economics Working Papers
No. 2013-005

Exchange Rate Regimes and Wage Comovements in a Ricardian Model with Moneyby
Yoshinori Kurokawa, Jiaren Pang and Yao Tang
October 2013This version: July 2016

UNIVERSITY OF TSUKUBA
Department of Economics
1-1-1 Tennodai
Tsukuba, Ibaraki 305-8571
JAPAN

Exchange Rate Regimes and Wage Comovements in a
Ricardian Model with Money∗
Yoshinori Kurokawa, Jiaren Pang, and Yao Tang†
July 6, 2016

Abstract
We construct a Ricardian model of trade with money and trade costs. The model
predicts that the nominal wages of the trading countries exhibit stronger positive comovements when the countries ﬁx their bilateral exchange rates, while comovementsof real wages are not aﬀected by exchange rate regimes. Our numerical experimentssuggest that a reduction in trade costs increases both nominal and real wage comovements, regardless of regimes. When downward nominal wage rigidity is introduced,
nominal wage comovements under the ﬁxed regime remain stronger than under the
ﬂexible regime and the diﬀerence is smaller on the shorter time horizon, while a slight diﬀerence in real wage comovements between the two regimes shows up and islarger on the shorter time horizon. When we consider membership in the Economicand Monetary Union of the European Union as a ﬁxed exchange rate regime, panel
regression results based on data from OECD countries are broadly consistent with ourmodel and numerical experiments.
JEL classiﬁcation: F16, F31, F45
Keywords: Ricardian model, ﬁxed exchange rate regime, currency union, trade, wage
comovements∗
The authors are grateful for suggestions and comments from the editor, two anonymous referees,
Kenneth Chan, Rachel Connelly, Deb DeGraﬀ, Masahiro Endo, Wilfred Ethier, John Fitzgerald, Tadashi
Hisanaga, Jyota Ishikawa, Yuji Kawano, Zorina Khan, Fukunari Kimura, Kozo Kiyota, Hiroshi Kodaira,
Steve Matusz, Atsushi Ohyama, Michihiro Ohyama, Hiroyuki Okada, Ke Pang, Gina Pieters, Pau Pujolas,
Kimihito Sakurai, Masao Satake, Hua Shang, Yoshimasa Shirai, Chetan Subramanian, Harutaka Takahashi, Hylke Vandenbussche, Chu-Ping Vijverberg, Wim Vijverberg, Hung-Jen Wang, Robert Zymek, andparticipants at the Spring 2011 Midwest International Economics Meetings, the 2011 JEA Autumn Meeting, the Chukyo/Kyoto International Conference on International Trade and Macroeconomic Dynamics,
the Japan Society of International Economics KANTO, the CEANA-NTU-TEA Session at the 2013 ASSA
Annual Meetings, the 2013 Chinese Economists Society Meeting, the 2014 NASM of the Econometric Society, and the 2014 SAET conference. This paper is a substantially revised version of the working paper,“Exchange Rate Regimes, Trade, and the Wage Comovements”. All errors are ours.
†
Kurokawa: Faculty of Humanities and Social Sciences, University of Tsukuba, 1-1-1 Tennodai, Tsukuba, Ibaraki 305-8571, Japan; E-mail: kurokawa.yoshi.fw@u.tsukuba.ac.jp. Pang: Department of
Finance, School of Economics and Management, Tsinghua University, Beijing 100084, China; E-mail:pangjr@sem.tsinghua.edu.cn. Tang: Corresponding author; Department of Economics, Bowdoin College,
9700 College Station, Brunswick, Maine 04011-8497, USA; E-mail: ytang@bowdoin.edu.

11Introduction

Prices in a country tend to comove positively with prices in its trading partner to which
it pegs its currency (e.g., Edwards, 1993; Calvo and Vegh, 1994; Willett, 1998). In addition, price levels and wage levels are strongly and positively correlated across countries(e.g., Crucini and Yilmazkuday, 2014), which indicates that wages can be approximately
representative of prices. These two observations suggest that under a ﬁxed exchange rate
regime, nominal wages should comove positively between trading countries. This possibility is important particularly for countries that peg their currency or join a currency
union because their wages can be tightly linked to wages in their trading partners. In fact,
McKinnon (2005, 2006) argues that it is nominal wage changes that would be the main
vehicle of international adjustment under a ﬁxed exchange rate.
Few studies, however, have theoretically or empirically investigated comovementsof nominal wages. This is probably because typical trade models are real models andthus do not explicitly address the monetary aspects of trade, although Dornbusch, Fischer
and Samuelson (1977) and Ito and Ohyama (1985) note that it is possible to extend thediscussion of the standard Ricardian model of trade to analyze nominal variables. This
paper now ﬁlls this void by developing a Ricardian model with money and trade costs andusing it to guide our empirical analysis on the relationship between exchange rate regimes
and wage comovements.
Our production structure extends the Ricardian model with a continuum of goods
developed by Dornbusch et al. (1977) to a stochastic model. We are similar to Eaton andKortum (2002) in that we extend the model of Dornbusch et al. (1977), but we diﬀer fromthem in that the productivity distribution is stochastic over time in our model while itis not in Eaton and Kortum (2002). Our preference structure is novel in the Ricardianmodel literature in that our utility function is a money-in-the-utility function. The asset
structure of our model follows Chari, Kehoe and McGrattan (2002).
We then use our model to analyze how exchange rate regimes aﬀect nominal wage
comovements between the trading countries, measured by nominal wage correlations. The

2

main prediction is that nominal wages comove strongly and positively between trading
countries that peg their currencies. This has implications for exchange rate policies. Undera ﬁxed exchange rate regime, wage inﬂation in a foreign country can be accompanied by
wage inﬂation in a home country. Under a ﬂexible exchange rate regime, on the other
hand, changes of exchange rates can shut out the repercussions of changes of nominal
wages in a foreign country through trade.
We also conduct two numerical experiments that extend the baseline model. The
ﬁrst experiment varies trade costs to test if trade intensity matters for the comovements.
We ﬁnd that through an increase in trade intensity, a reduction in trade costs increases
nominal wage comevements under both the ﬁxed and ﬂexible exchange rate regimes. The
second experiment introduces downward nominal wage rigidity to guide and interpret
regressions in the short run vs. the long run. We ﬁnd that the comovements between
home and foreign nominal wages decline under both regimes when rigidity is introduced.
Meanwhile, nominal wage comovements under the ﬁxed regime remain stronger than under
the ﬂexible regime and the diﬀerence between the two regimes is smaller on the shortertime horizon.
Immediately, a natural question is whether our ﬁndings about nominal wage comovements can be extended to real wage comovements. This is important particularly forhouseholds because their real purchasing power of earnings can be tightly linked to that in
the trading partners. In our baseline model in which money is neutral, it is not surprisingthat exchange rate regimes do not interfere with real wage comovements. Meanwhile, ournumerical analysis shows that a reduction in trade costs tends to increase real wage comovements under both the ﬁxed and ﬂexible exchange rate regimes. When we introduce
downward nominal wage rigidity to break money neutrality, comovements in real wages
decline slightly under both regimes, while a small diﬀerence in real wage comovements
between the two regimes shows up and is larger on the shorter time horizon.
The theoretical results regarding the eﬀects of (1) exchange rate remiges, (2) trade
costs, and (3) nominal wage rigidity provide direct guidance to the following empirical3

questions: Do nominal and real wage comovements diﬀer (1) under the ﬁxed regime vs.
the ﬂexible regime, (2) with diﬀerent levels of trade intensity, and (3) in the short-run vs.
the long-run? To examine these questions, we collect panel data of 33 OECD countries
from 1971 to 2012, and perform empirical analysis at one-year and four-year frequencies
under the premise that nominal wage rigidity is more likely at the one-year frequency.
The regression results suggest that if a country and its main trade partner were in
the Economic and Monetary Union (EMU) of the European Union, then their nominal
wages experienced signiﬁcantly stronger comovements. The positive eﬀects of the EMU
on comovements are smaller in the short run than in the long run, although the diﬀerenceis statistically insigniﬁcant. When we restrict the sample to EMU countries, we ﬁnd someevidence that these countries experienced stronger positive nominal wage comovements
compared to the pre-euro era. For the non-EMU countries, there is no evidence that
non-currency-union pegs strengthened nominal wage comovements. Turning to real wage
comovements, country pairs with EMU membership had a more positive eﬀect on real
wage comovements in the short run than in the long run, although the eﬀects were insigniﬁcant. Lastly, the trade intensity between two countries is positively correlated withthe comovements of both nominal and real wages. These ﬁndings are broadly consistent
with our model and numerical analysis.
Our paper thus makes the following contributions. First, it adds to the literatureon exchange rates and wages. While many studies analyze the relationship between realexchange rates and real wages (e.g., Goldberg and Tracy 2000; Campa and Goldberg
2001), our paper examines the relationship between nominal exchange rates and bothnominal and real wages. In particular, our paper reveals that the eﬀects of trade on thenominal wage comovements between the trading countries are diﬀerent under the ﬁxed
and ﬂexible exchange rate regimes. To the best of our knowledge, our paper is the ﬁrst
to use a Ricardian model to analyze the relationship between exchange rates and wage
comovements.
Second, our paper adds to the empirical evidence of nominal wage comovements.

4

There are three papers that also examine this subject and are closely related to our work.
The ﬁrst, Budd, Konings and Slaughter (2005), highlights the comovements of nominal
wages within a multinational ﬁrm through internal risk sharing. The second, Robertson(2000), highlights the comovements of nominal wages, resulting from emigration, between
the border region of Mexico and the U.S. and between the interior and border regionsin Mexico. The third, Lamo, Perez and Schuknecht (2008), highlights the comovementsof public and private sector nominal wages over business cycles since the 1960s in theeuro area and a number of other OECD countries.1 While these previous works focus oninter- and intra-country nominal wage comovements due to internal risk sharing within
a multinational ﬁrm and emigration, we establish that trade and exchange rate regimes
provide an alternative cause of nominal wage comovements.
Third, our paper adds to the literature on comovements of exchange rates andmacroeconomic real variables. For example, Stockman (1987), Flood and Rose (1995),
Obstfeld and Rogoﬀ (1995a), Stockman (1998), Kollmann (2001), and Duarte, Restuccia
and Waddle (2007) have analyzed comovements between nominal/real exchange rates andreal variables such as output, but have not analyzed those between the domestic andforeign real variables. Baxter and Stockman (1989) and Chari et al. (2002) have analyzed
both types of comovements, and the former study has also examined an eﬀect of exchange
rate regimes. In this line of studies, our paper is the closest to Baxter and Stockman(1989) in that both examine an eﬀect of exchange rate regimes on comovements between
the domestic and foreign real variables. However, our paper mainly studies comovementsof real wages while they study comovements of output and government consumption.
Additionally, our paper examines eﬀects of trade intensity and nominal wage rigidity as
well.
Fourth, our paper adds to the literature on the relationship between real exchange
rates and the relative price of nontradable goods (e.g., Betts and Kehoe 2006, 2008). While1
Lamo et al. (2008) also study causal linkages between public and private sector wages, i.e., the public/private wage leadership. Their causality analysis suggests that although inﬂuences from the private
sector appear on the whole to be stronger, there are direct and indirect feedback eﬀects from a public wage
setting in a number of countries as well. See the references in their paper for studies on wage leadershipin a particular country (primarily Sweden and several others).

5past studies have derived this relationship from traditional real exchange rate theory, ourpaper derives it from a Ricardian model of trade with money and thus provides it with analternative theoretical foundation.
The rest of this paper is organized as follows. In Section 2, we construct a Ricardianmodel with money and trade costs and derive the predictions on wage comovements. We
present supporting empirical evidence in Section 3. Section 4 concludes by oﬀering a brief
discussion of the results.

2

TheoryIn this section, we construct a Ricardian model of trade with money and trade costs andthus address the monetary aspects of trade. As mentioned in the introduction, the setupof the model borrows from two main sources, ﬁrst, the Ricardian models (Dornbusch etal., 1977; Eaton and Kortum, 2002), and second, models of money and exchange rates(Chari et al., 2002). The model in our paper is highly stylized, but it allows us to obtainclear insights about the eﬀects of exchange rate regimes and trade on wage comovements.

2.1

Model setup

There are two countries, home and foreign. The variables associated with the home andforeign countries are indicated by superscripts H and F , respectively. Each country iscapable of producing the same continuum of tradable goods. The goods are indexed byi ∈ [0, 1]. There exist iceberg trade costs τ ≥ 0, i.e., when a country ships 1 + τ unitof goods to the other country, only 1 unit arrives. Because of trade costs, some tradable
varieties may not be traded in equilibrium. Each country also produces a nontradable
good, z. As in typical Ricardian models, there is only one input factor, labor, and it isperfectly mobile across industries within a country but immobile across countries.2 Thus,
wages are the same across industries within a country but can be diﬀerent across countries.
2

Because our focus is on labor, similar to Eaton and Kortum (2002), our model does not include capital,
maintaining the model in a simple form. In Section 3.1, however, we will discuss migration and capital
movements and include their controls in our regressions.

6

The asset structure follows that of Chari et al. (2002). In each period t, the twocountry world economy experiences one of ﬁnitely many states, st . The history of states up
through period t is denoted by st = (s0 , s1 , ..., st ). The initial realization of s0 is given. In
this economy, there are complete, state-contingent, and one-period bonds denominated in
the home currency, and both home and foreign consumers can buy and sell these bonds.3
For country j = H, F , the period preference of the inﬁnitely lived representative
consumer is
(
Utj =

Ctj

)1−ζ

1−ζ

(
−κ

Ljt

)1+γ

1+γ

(
+ χh

Mtj

)
,

Ptj

where
[(∫
Ctj =

0

1

η
) η−1
·ϵ

η−1
Ctj (i) η di]
· Ctj (z)1−ϵ,

ζ, κ, γ, χ and η > 0 and 0 < ϵ < 1. To conserve space, we use the subscript t to indicatethat a variable is in st . For example, Utj stands for U j (st ), the utility in st . Here, Ctj (i)denotes the consumption of tradable good i in country j, and Ctj (z) is the consumption of
the nontradable good in country j. The parameter η governs the elasticity of substitution
between tradable goods, and ϵ is the fraction of expenditure that goes to the tradable
goods. The quantity Ljt is labor supply. The variables Mtj and Ptj are money supply andthe aggregate price level.
3

Including bonds denominated in the foreign currency would be redundant as this does not add to thestructure of the bond market.

7

The period budget constraint in each country is∫ 1
PHt (i) CtH (i) di + PtH (z) CtH (z) + MtH +
0

∑

H
H
qt+1|t
Bt+1

st+1

H
H
H
H
= WtH LHt + Mt−1 + Bt + Πt + Tt ,
∫ 1
∑
H
F
PF t (i) CtF (i) di + PtF (z) CtF (z) + MtF +qt+1|t
Bt+1
/et
0

st+1

F
= WtF LFt + Mt−1
+ BtF /et + ΠFt + TtF .

There is also a borrowing constraint in each countryH
Bt+1≥ −PtH b̄H ,F
Bt+1/et ≥ −PtF b̄F .

The variables Pjt (i), Ptj (z), and Wtj are the nominal price of tradable good i, the nominaljprice of nontradable good, and nominal wages, all denoted in the local currency.4 Bt+1
isthe quantity of the nominal bond bought in period t and state st with payoﬀs contingent
on some particular state st+1 at t + 1; one unit of this bond pays one unit of the homeHcurrency in period t + 1 if the particular state st+1 occurs and 0 otherwise. qt+1|t
is thisH
H /q H clearly. e is the nominal exchangebond’s price in the home currency, and qt+1|t= qt+1ttrate, deﬁned as the price of foreign currency in the home currency. Πjt and Ttj are proﬁts
of ﬁrms and a nominal transfer from the government of country j. The positive constantb̄j is the constraint on real borrowing. Our budget constraint is similar to that in theChari et al. (2002) model, except that ours has the consumption of nontradable goods.
Given the prices Pjt (i) and Ptj (z), the minimization of the cost of Ctj yields thefollowing unit cost of Ctj , which we refer to as the price of Ctj
Ptj =

1
] 1−η
ϵ(
)1−ϵ
[
] [∫ 1ϵ−11−η−ϵPtj (z).
ϵ (1 − ϵ)(Pjt (i))
di04

A tradable good i that the consumer buys can be a home or foreign good, so there is no superscript j
for the variable Pjt (i). Instead, we use the subscript j to indicate that it is the price that the consumer
in country j actually pays.

8

Hence, the budget constraint in each country can be written as

PtH CtH + MtH +

∑

H
H
H
H
H
H
qt+1|t
Bt+1= WtH LHt + Mt−1 + Bt + Πt + Tt ,st+1

PtF CtF + MtF +

∑

H
F
F
qt+1|t
Bt+1/et = WtF LFt + Mt−1
+ BtF /et + ΠFt + TtF .

st+1

The production technology for tradable and nontradable goods is
Ytj (i) = Ajt (i) Ljt (i) ,Ytj (z) = Ajt (z) Ljt (z) ,where Ajt (i) and Ajt (z) are the stochastic productivities. Here, we do not specify theirstochastic processes because it is not necessary for the derivations of Propositions 1 and
2 in Section 2.2. In Section 2.3, we will specify them for further analysis.
The market for each tradable good is perfectly competitive. The home producersof good i have to compete with foreign producers of the same good. Home and foreign
consumers only buy from the producers with the lowest price. Consequently, the domestic
prices posted by the home and foreign ﬁrms for good i in their respective local currencies
arePtH (i) = WtH /AHt (i) ,
PtF (i) = WtF /AFt (i) ,respectively, but the prevailing market prices that consumers in the home and foreigncountries actually pay are now given by{}PHt (i) = min PtH (i) , (1 + τ ) PtF (i) et ,{}PF t (i) = min (1 + τ ) PtH (i) /et , PtF (i) .
FAs in Dornbusch et al. (1977), we assume that AH
t (i) /At (i) is strictly decreasing in

9

i. Then it follows that PtH (i) /PtF (i) is strictly increasing in i. Thus, there exists a cutoﬀ
variety ktF such that for all i ∈ [0, ktF ), PtH (i) < (1 + τ ) PtF (i) et holds. Similar, there
exists a cutoﬀ variety ktH < ktF such that for all i ∈ (ktH , 1], (1 + τ ) PtH (i) /et > PtF (i)holds. Therefore, varieties in [0, ktH ) are produced only by the home country, while varietiesin (ktF , 1] are produced only by the foreign country. The varieties i ∈ [ktH , ktF ] are nottraded due to the trade costs and are produced in both countries.
The market for nontradable goods is also perfectly competitive. Consequently, thelocal-currency prices for the nontradable goods are
Ptj (z) = Wtj /Ajt (z) .

As in Chari et al. (2002), money is introduced into the utility function. The money
supplies in the two countries follow stochastic processes, to be speciﬁed in Section 2.2 forj
diﬀerent exchange rate regimes. In country j = H, F , any new money balance Mtj − Mt−1
jis distributed to households through lump-sum transfer. That is, Ttj = Mtj − Mt−1
. As

in Chari et al. (2002), the equilibrium exchange rate is determined in the asset (bond)market and is given by the following ﬁrst order condition()ζ
PtH CtH
λFt
δ
=
δ,
et =
( )ζ
λH
PtF CtFt(1)

where δ is a constant depending on the state of the economy in the initial period, and is
the marginal utility of consumption per the home currency in the home country relative toFthat in the foreign country in the initial period. The variables λHt and λt are the marginalutility associated with the home and foreign nominal wealth, respectively. Unlike Chariet al. (2002), our focus is not on nominal price rigidity. Hence, we assume ﬂexible prices.

10

The market clearing conditions are

LH
t =

∫ ktF

H
LH
t (i) di + Lt (z) ,

0

∫ 1
LFt =

ktH

LFt (i) di + LFt (z) ,YtH (i) = CtH (i) + CtF (i) (1 + τ )∀ i < ktH ,YtF (i) = CtH (i) (1 + τ ) + CtF (i)∀ i > ktF ,Ytj (i) = Ctj (i)∀ ktH ≤ i ≤ ktF ,Ytj (z) = Ctj (z) ,BtH + BtF = 0.

At the beginning of each period, both monetary shocks and productivity shocks,
which will be introduced in Sections 2.2 and 2.3, are observed by all players in the economy. Firms then post prices, consumers make purchase decisions, production occurs, andmarkets clear. Because our main interests are in the role of exchange rate regimes in anchoring nominal wages in the long run, for most of the paper we assume that all prices andwages are ﬂexible, which indicates that nominal variables do not aﬀect real variables. In
the numerical experiments in Sections 2.3 and 2.4, we change this assumption and explore
a version of the model with ﬂexible prices but downward-rigid nominal wages.

2.2

Exchange rate regimes and the nominal wage comovements

First, we characterize the general relationship between the changes in home and foreign
nominal wages in Proposition 1. We brieﬂy outline the derivations here and leave theproof to the Supplementary Appendix. Using the relationship between nominal prices andnominal wages implied by the technology and market structure, we can express the realexchange rate as a function of the nominal exchange rate, nominal wages, productivities,

11and prices:

et

(

PtF
=
PtH

et WtF
WtH)1−ϵ (AHt (z)AFt (z)

)1−ϵ
Dt ,

(2)

where
 ∫ kH (

 1 ϵ
)
)
)
∫ (
∫ F(
H (i) 1−η di + kt P F (i) e 1−η di + 1 P F (i) e 1−η di 1−η
(1
+
τ
)
P
t
t
t
t
t
0
ktF
ktH

Dt =  ∫ H (
.
F
)
(
)
(
)
∫
∫
kt
H (i) 1−η di + kt P H (i) 1−η di + 1 (1 + τ ) P F (i) e 1−η di
P
F
t
t
t
t
0
k
kH
t

t

t

The term Dt can be viewed as the ratio of the price index for tradable goods in the foreigncountry to that in the home country. The presence of the term Dt is due to the trade
costs τ . When τ is zero, Dt = 1.5
From equation (2), we now obtain Proposition 1 that characterizes the general relationship between home and foreign wage growth.
Proposition 1. The relationship between growth in home nominal wages and the foreigncounterpart is
WtH
WtF
=
H
F
Wt−1
Wt−1

(

et
et−1

) ϵ (
ϵ−1

Dt
Dt−1

) 1 (
1−ϵ

F
PtH Pt−1
H PF
Pt−1
t

) 1

1−ϵ

F
AH
t (z) At−1 (z).
FAH
t−1 (z) At (z)(3)

Based on Proposition 1, we can decompose the change in home nominal wages intochanges in foreign nominal wages, nominal exchange rates, the relative price of tradable
goods, home and foreign aggregate prices, and productivities of home and foreign producersof the nontradable good. Intuitively, if the nominal exchange rate is ﬂexible, it is less likelythat the change in home nominal wages must match the foreign counterpart. Hence, we
expect comovements of nominal wages to be stronger under the ﬁxed exchange rate regime.
Next, we further specify our model by making explicit assumptions about the utilityof the real balance and the stochastic processes governing money supplies, which arerequired to establish Proposition 2. Speciﬁcally, for country j = H, F , we make the5

Depending on the distribution of tradable productivities in the two countries, the relationship between
Dt and τ can be complex. For instance, for positive values of τ , if distributions of tradable productivities
F
in the two countries are mirror images to each other (i.e., AH
t (i) = At (1 − i) for all i), then Dt is also 1.

12

following assumptions:()()• (a) The utility of the real balance is h Mtj /Ptj = ln Mtj /Ptj .
• (b1) When the exchange rate is ﬂexible, the money supply of country j follows thestochastic process
( )
)
j (
Mtj = exp µjt Mt−1
1 + gj ,F
where g j is a constant, and µHt and µt are zero-mean i.i.d. shocks with a common

cdf Φ (µ).
• (b2) When the exchange rate is ﬁxed, the foreign money supply follows the stochastic
process( ) F ()
MtF = exp µFt Mt−1
1 + gF ,where g F is a constant, and µFt is a zero-mean i.i.d. shock with the cdf Φ (µ). The
home country sets MtH to ﬁx the exchange rate.
• (c) Both monetary shocks are independent of the productivity processes.6
Based on the assumptions, the ﬁrst order conditions with respect to labor supply
and the expression for exchange rates, we can write the expression for the nominal wage
growth rate of the home country under the ﬂexible exchange rate regime as
(
ln

WtH
H
Wt−1

)

(
= ln(1 + g H ) + µH
t + γln

6

LH
t
LH
t−1

)
.

This assumption is common in the literature on macroeconomics, especially international macroeconomics (Hairault and Portier, 1993; Chari et al., 2002; Devereux and Sutherland, 2007). In the spirit ofFriedman and Schwartz (1963) and Romer and Romer (1989), we regard monetary shocks as nominal disturbances independent of the real side of the economy and the policy response of the central banks to thereal economy. Therefore, we believe that it is reasonable to assume independence between the monetaryshocks and the productivity processes.

13Under the ﬁxed regime, the nominal wage growth rate of the home country is
(
ln

WtH
H
Wt−1

)

(
= ln(1 + g

F) + µFt + γln

LH
t
LH
t−1

)
.

Similarly, we can write the nominal wage growth rate of the foreign country under bothregimes as
(
ln

WtF
F
Wt−1

)

(
= ln(1 + g F ) + µFt + γln

LFt
LFt−1

)
.

From the last three equations, it is obvious that when the exchange rate regime is ﬁxed, thecomovements between home and foreign wages are caused by both the identical monetary()
eﬀects, ln 1 + g F + µFt , and the correlation in labor supply changes. Under the ﬂexible
exchange rate regime, the monetary eﬀects in the two countries are not correlated unlessthe monetary shocks are correlated. In this case, the comovements in wages will be weakerbecause the comovements are caused by only the correlation in labor supply changes.
We now formalize these results regarding nominal wage comovements under diﬀerent exchange rate regimes as Proposition 2, and leave the proof to the Supplementary
Appendix.
Proposition 2. Under assumptions (a) and (c), nominal wage comovements between the
countries are more positive or less negative under the ﬁxed exchange rate regime (assumption (b2)), compared to the ﬂexible exchange rate regime (assumption (b1)). To be speciﬁc,(corrF X

ln

(

WtH
H
Wt−1

)

(
, ln

WtF
F
Wt−1

))

(
− corrF L

(
ln

WtH
H
Wt−1

)

(
, ln

WtF
F
Wt−1

))
≥ 0,

where F X and F L denote the ﬁxed and ﬂexible exchange rate regimes, respectively. The
F
strict equality holds only when monetary shocks µHt and µt are perfectly correlated.

14

2.3

The eﬀects of trade costs and downward nominal wage rigidity on
nominal wage comovements

In this section, we examine how two additional factors, trade costs and downward nominal
wage rigidity, may aﬀect nominal wage comovements under each of the exchange rate
regimes. Given that we use the Ricardian model of trade to analyze the relationshipbetween exchange rate regimes and wage comovements, it is important to examine whether
trade intensity aﬀects our main ﬁndings. Thus we vary trade costs to see if trade intensity
matters for the comovements. Intuitively, if trade costs are reduced, more tradable goods
will become traded, potentially leading to stronger alignment of nominal wages. Downward
nominal wage rigidity is also important because it is deemed a salient feature of the labormarkets in the Eurozone (Schmitt-Grohé and Uribe, 2013) and may make nominal wage
comovements weaker, particularly on the shorter time horizon when downward rigidity
is more likely to be present. Thus we introduce downward nominal wage rigidity andcompare the results on the shorter and longer time horizons to guide and interpret our
regressions in the short run vs. the long run in Section 3.
As it is diﬃcult to obtain analytic results related to trade costs and downward nominal wage rigidity in our model, we resort to numerical experiments. Similar to Proposition
2, we measure wage comovements as the correlation coeﬃcient between wage growth rates.
First, without introducing nominal wage rigidity, we calculate the correlation coeﬃcient
between nominal wage growth rates under both ﬂexible and ﬁxed exchange rate regimes
for diﬀerent values of the trade costs τ . We then repeat the calculations for a setup with
ﬂexible nominal prices and downward-rigid nominal wages.
The values of key parameters are obtained from the literature. To be precise, theconstant relative risk aversion parameter (ζ) is 3 (Hubbard, Skinner and Zeldes, 1994), thedisutility of labor parameter (γ) is 0.262 (Imai and Keane, 2004), the share of all tradable
goods in total expenditures (ϵ) is 0.3 (Arkolakis and Ramanarayanan, 2009), the elasticity
of substitution between tradable goods (η) is 1.5 (Backus, Kehoe and Kydland, 1994), andthe upper bound of trade costs τ is 0.6 (Xu, 2003).

15

We now specify the productivity processes. For country j = H, F , we make thefollowing assumption:• (d) The productivities for tradable and nontradable goods are()
Ajt (i) = Aj (i) exp ajt + αtj ,()
Ajt (z) = Aj (z) exp ajt (z) + αtj (z) ,where ajt and ajt (z) are the deterministic trends of the productivities, and αtj andαtj (z) are the stochastic components. The stochastic components follow AR(1) processesjαtj = ρj αt−1
+ ujt ,jαtj (z) = ρj (z) αt−1(z) + vtj ,where ujt and vtj are zero-mean shocks and they can be correlated.
Following Kehoe and Perri (2002), we assign a value of 0.95 to the persistence of
tradable and nontradable productivity shocks in both countries (ρj and ρj (z)). As in
Stockman and Tesar (1995), the covariance matrix of productivity shocks is speciﬁed as(
V [uHvtH uFt
t


3.62


)
1 
1.23
vtF ]′ =
100 1.21


0.51


1.23 1.21 0.51


1.99 0.51 0.27
.

0.51 3.62 1.23

0.27 1.23 1.99

We follow Chari et al. (2002) to set the size of home and foreign monetary shocks to
be 0.023. We assume that the monetary shocks are independent of each other. Consistent
with assumption (c), the monetary shocks are also independent of productivity shocks.
To study the eﬀects of downward nominal wage rigidity, it is important to havefrequent drops in nominal wages in the ﬂexible wage equilibrium. We set the growth rate16

of money supplies in both countries (g H and g F ) to be 0.02 such that nominal wages
would drop in about half of the numerical experiments. To reduce computational timeand improve numerical stability, we specify the baseline productivity for tradable goods as
AH (i) = 2 − i and AF (i) = 1 + i. We set the deterministic trend growth in both tradable
good productivity and nontradable good productivity to be 0.021, the average growthrate of labor productivity in the sample countries for our empirical analysis in Section 3.
Other productivity parameters are normalized to 1 because they aﬀect the levels but not
the growth rates of nominal wages.
We also need to deal with trade deﬁcits because our model does not impose a balanced trade condition so that international borrowing and lending are possible. As tradedeﬁcits are not determined endogenously in our model, we follow the approach of Dekle,
Eaton and Kortum (2007, 2008) and take trade deﬁcits from the data, as do di Giovanni,
Levchenko and Zhang (2014) in the unbalanced-trade version of their model. To be speciﬁc, the mean trade deﬁcits are -0.7% of the GDP, which is the average level of current
account deﬁcits of countries in our sample. We further assume that trade deﬁcits follow
an AR(1) process with a persistence parameter of 0.7 and shocks to trade deﬁcits have astandard deviation of 2.23%. These two values are obtained from running AR(1) regressions of the current account deﬁcits for each country in our sample, and taking the averageof the relevant estimates across countries.
We vary τ between 0 and 0.6 and the step size is 0.01. For each value of τ , wedraw 50 sets of productivity and monetary shocks, and compute the correlation between
nominal wage growth rates using the 50 pairs of calculated nominal wage growth rates inthe two countries. Repeating this process 100,000 times, we obtain 100,000 correlationcoeﬃcients for each value of τ . Lastly, we compute the average correlation coeﬃcient foreach τ and plot the average against τ .
It should be noted that the purpose of our numerical experiments is to study thequalitative eﬀects of trade costs and downward-rigid nominal wages; we do not seek tomatch any moments or statistics of the data.

17

First, for the case of no nominal wage rigidity, we plot the correlations between
the home and foreign nominal wage growth rates for diﬀerent values of trade costs τ in
Figure 1. As we can see, a reduction in trade costs τ tends to increase the correlation
between the home and foreign nominal wage growth rates under both the ﬁxed and ﬂexible
exchange rate regimes. This implies a negative relationship between trade costs and nominal wage comovements regardless of the regime. Intuitively, when more trade is enabled
by a decrease in trade costs, nominal wages in the two countries are more closely linked.
Next, we introduce downward nominal wage rigidity, a feature that is not includedin the above theoretical model. For each draw of shocks, we compute the equilibrium with
ﬂexible nominal prices and wages. If this ﬂexible-wage equilibrium requires a decreasein nominal wage(s), we follow Benigno and Ricci (2011) and impose that the nominal
wage(s) is equal to wage(s) in the last period and recalculate the equilibrium. To guideand interpret our empirical analysis in Section 3 that uses data on both shorter and longer
time horizons, we compute the comovements of downward-rigid nominal wages over one
period and four periods. The results of these two numerical experiments are plotted in
Figures 2 and 3. Comparing Figure 2 to Figure 1, we can see that the wage rigidity
reduces the correlations between nominal wage growth rates under both the ﬂexible andﬁxed exchange rate regimes.
To see how diﬀerent the eﬀect of ﬁxed exchange rate regimes on nominal wage
comovements is on the shorter vs. longer time horizons with wage rigidity, we plot in
Figure 4 the diﬀerences in downward-rigid nominal wage correlations between the ﬁxed andﬂexible regimes for one-period (Figure 2) and four-period (Figure 3) experiments. Figure
4 suggests that, when the time horizon is shorter, the positive eﬀect of ﬁxed exchange
rate regimes on nominal wage comovements is weaker. In other words, the longer the time
horizon is, the stronger the positive eﬀect is. This is because, as time goes by, inﬂation andproductivity growth tend to lift equilibrium nominal wages and hence downward rigidity
is less likely to be binding.

18

2.4

Comovements of real variables

So far we have focused on nominal wages. Immediately, a natural question is whether our
ﬁndings about nominal wages can be extended to real wages and other real variables suchas real exchange rate, consumption, labor, and output. First, given that our model features
ﬂexible prices and wages, it is intuitive that money is neutral and that the comovementsof the real variables are not aﬀected by exchange rate regimes. In particular, the choiceof exchange rate regime should not aﬀect real wage comovements in our model. We test
this hypothesis in the regressions.
Next, as in Section 2.3, we carry out numerical experiments to study the eﬀect oftrade costs and downward nominal wage rigidity. Figure 5 is the real wage counterpart for
Figure 1. As can be seen, a reduction in trade costs tends to increase real wage comovements under both exchange rate regimes. Figures 6 to 8 are the real wage counterpartsfor Figures 2 to 4, respectively. When downward nominal wage rigidity is introduced,
comovements in real wages decline slightly under both regimes, and there appears a small
diﬀerence between the real wage comovements under the two regimes. Unlike the results
for nominal wage comovements, the relative eﬀects of the ﬁxed regime on real wage comovements are larger on the shorter time horizon, albeit the diﬀerences in correlations are
small in magnitude.
Intuitively, when both nominal prices and wages are ﬂexible, changes in money
supply aﬀect nominal prices and wages in similar ways, leaving the real wages unaﬀected bymonetary factors. However, if nominal wages are less ﬂexible than prices due to downward
nominal wage rigidity, then changes in the money supply will aﬀect real wages. When two
countries peg their exchange rate, money supplies will have similar eﬀects on real wages
in the two countries. This will lead to real wage comovements, which will be stronger on
the shorter time horizon when downward rigidity is more likely to be binding. However,a full investigation of the role of wage rigidity is beyond the scope of this paper.
Finally, it is worth pointing out that our model is related to the literature on therelationship between real exchange rates and the relative price of nontradable goods. Two

19

recent papers on the subject, Betts and Kehoe (2006, 2008), ﬁnd that for pairs of countries
that trade intensively or maintain a stable bilateral real exchange rate, the relative priceof nontradable goods has a stronger relationship with their bilateral real exchange rate.
Our Ricardian model implies a similar relationship. Substituting Ptj (z) = Wtj /Ajt (z) into
equation (2) gives

et

(
)1−ϵ
PtF
PtF (z)
=
D
e
.
t
t H
PtH
Pt (z)

This indicates a simple decomposition of the real exchange rate into two components—one
due to failures of the law of one price, and the other due to cross-country ﬂuctuations in
the relative price of nontradable goods. Suppose now that trade costs are zero (τ = 0),
that is, trade intensity is the largest. Then the law of one price holds (Dt = 1), and thus
the real exchange rate is determined completely by the relative price of nontradable goods.

3

Empirical Evidence

To test our theory, we empirically examine the comovements between the wage growth
rates of a country and its trade partner and how the wage comovements may be aﬀectedby exchange rate regimes, trade costs, and downward nominal wage rigidity.

3.1

Regression speciﬁcation

We derive the regression speciﬁcations from our theory. Proposition 1 and assumption (d)about productivity processes imply that
(
ln

WtH
H
Wt−1

)

(

)

(
)
(
(
)
)
F
ϵ
et
Dt
PtH Pt−1
1
1
· ln
· ln
· ln
+
+
H
ϵ−1
et−1
1−ϵ
Dt−1
1−ϵ
Pt−1
PtF
(
) (
) (
)
F
H
H
F
F
H
F
+ ∆aH
.
t (z) − ∆at (z) + ρ (z) αt−1 (z) − ρ (z) αt−1 (z) + vt − vt

= ln

WtF
F
Wt−1

+

(4)

This equation suggests a linear regression of home nominal wage growth on foreign nominal wage growth, the change in the nominal exchange rate, the change in the price index
of tradable goods, inﬂation diﬀerential, and the trend and cyclical components of produc-20tivities.
To test the prediction of Proposition 2 that the nominal wage comovements will bestronger under the ﬁxed exchange rate regime, we include the interaction term between theﬁxed exchange rate regime and foreign nominal wage growth in the following estimation
equation. Because our numerical experiments suggest that the trade costs are negatively
correlated with nominal wage comovements regardless of exchange rate regimes, we add
trade intensity, a variable inversely related to τ , to the regression and interact it with thechanges in foreign nominal wages. In addition to trade and exchange rates, it is known
that migration and capital movements can also aﬀect wage comovements.7 Hence, we
add these two variables and their interactions with foreign nominal wage growth to theregression.
7

There is a vast literature on trade and migration. Dornbusch et al. (1977) and Treﬂer (1997), forexample, analyze the eﬀects of immigration in a model of Ricardian trade with a continuum of goods.
They consider a change in relative size as immigration. Then nominal wages in the host country fall to
produce goods with relatively low productivity that were not previously produced in the host country.
Likewise, nominal wages in the home country rise to shut down goods with relatively low productivity thatwere previously produced in the home country. Thus immigration causes nominal wages to fall in the hostcountry but to rise in the home country, changing the range of goods produced in each country. It canalso be shown that real wages fall in the host country but rise in the home country. Migration can thus
cause the (negative) comovements of both nominal and real wages.
There is also a sizable literature on trade and capital movements. For example, a well-known argument
concerns trade vs. capital movements in the H-O model. Consider the Dixit and Norman (1980) integrated
world equilibrium in an integrated economy in which goods and factors are free to move across countries.
Then trade in goods can achieve this integrated world equilibrium without factor movements across countries. Alternatively, capital movements can also achieve it without trade in goods (or labor mobility acrosscountries). Thus capital movements are substitutes for trade in goods. In either case, after trade or capital
movements, factor prices become equalized across countries. That is, nominal wages go up in one country
but go down in the other country. It can also be shown by the Stolper-Samuelson argument that real
wages go up in one country but go down in the other country. Thus capital movements can provide analternative to trade as a cause of (negative) comovements of both nominal and real wages.

21Thus our regression speciﬁcation is
(
ln

H
Wkt
H
Wkt−1

)

(
= β0 + β1 · ln

F
Wkt
F
Wkt−1
(

)

(
+ β2 · pegkt · ln

F
Wkt
F
Wkt−1

)
+ β3 · pegkt

)
(
)
F
F
Wkt
Wkt
+ β4 · tradekt · ln
+ β5 · tradekt + β6 · F DIkt · ln
+ β7 · F DIkt
F
F
Wkt−1
Wkt−1
)
(
F
Wkt
+ β9 · migrationkt+ β8 · migrationkt · ln
F
Wkt−1
)
(
(
)
(
)
H PF
ekt
Dkt
Pkt
kt−1
+ β10 · ln
+ β11 · ln
+ β12 · ln
H
F
ekt−1
Dkt−1
Pkt−1
Pkt
(
)
F
H
F
+ β13 · ∆aH(5)
kt (z) − ∆akt (z) + β14 · αkt−1 (z) + β15 · αkt−1 (z) + ϵkt ,H is the nominal wage index of country k; W F is the nominal wage index forwhere Wktkt

the base country of country k; pegkt is a dummy variable that is equal to 1 if country k
pegs its exchange rate to its base country, and 0 otherwise; tradekt is a measure for tradeintensity between country k and its base country; F DIkt and migrationkt are measuresfor bilateral FDI and migration, respectively; ekt is the nominal exchange rate between
country k and its base country; Dkt is the ratio of the CPI of tradable goods in country
H and P F are country k’s CPI andk’s base country to its counterpart in country k; PktktF
its base country’s CPI, respectively; ∆aHkt (z) − ∆akt (z) is the diﬀerence in changes in thetrends of nontradable-sector labor productivities between country k and its base country;
H
F
αkt−1
(z) and αkt−1(z) are lag levels of cyclical productivities of country k and its basecountry, respectively; and ϵkt is the error term that contains the productivity shock term
H −v F and other disturbances. In actual regressions, we also include country ﬁxed eﬀects
vkt
kt

to control for the inﬂuence of other time-invariant country characteristics.
Our intention is to use the regression analysis to estimate the partial correlation between home and foreign nominal wage growth rates under diﬀerent exchange rate regimes.
We do not intend to identify the causality between nominal wages because they are equilibrium objects. In particular, our main interest is in the parameter β2 , which measures the
additional nominal wage comovements experienced by countries with a ﬁxed exchange rate
regime relative to those with a ﬂexible regime. Proposition 2 is substantiated if β2 > 0.

22

Our model implies that the exchange rate regime does not aﬀect real wage comovements. To test this implication, we estimate an equation that is identical to equation (5)except that nominal wages are replaced with real wages. If the coeﬃcient on the interaction between the peg variable and foreign real wage growth, β2 , is statistically insigniﬁcant,then the implication of our model with regard to real wage comovements is supported.
Our numerical experiments suggest that a reduction in trade costs increases bothnominal and real wage comovements. Given that trade intensity is usually negatively
associated with trade costs, we expect the coeﬃcient on the interaction between tradeintensity and foreign wage growth, β4 , to be positive.
Meanwhile, in our numerical experiments with downward nominal wage rigidity,
the nominal wage comovements under the ﬁxed exchange rate regime remain stronger
than under the ﬂexible regime, and the diﬀerence between the two regimes is smaller on
the shorter time horizon. In contrast, the diﬀerence in real wage comovements between
the two regimes is larger on the shorter time horizon. To test these predictions, we
run regressions with variables deﬁned at one-year and four-year frequencies, respectively,
under the premise that nominal wage rigidity is more likely to be present at the one-year
frequency. Based on the results of numerical experiments, we expect that in regressions
with nominal wage growth, β2 is positive and signiﬁcant in both annual and quadrennial
regressions, and that it is smaller in the annual regressions. In regressions with real wage
growth, we expect that β2 is more positive in the annual regressions than in the quadrennial
regressions.
Lastly, because our speciﬁcation incorporates trends in productivity, the wage comovements that we examine empirically are the cyclical ﬂuctuations in wages aroundtrends.

3.2

Data

Our regression analysis uses nominal wage data from the OECD Library (www.oecdilibrary.org), which provides detailed wage information of OECD countries. Nominal wages

23

are measured by the index for nominal hourly earnings in manufacturing sectors.8 Our
choice of nominal wage measurement, identical to that in Levchenko and Zhang (2016), is
consistent with the theory that requires a country-speciﬁc measure for nominal wages.
Our deﬁnition of peg is based on Ilzetzki, Reinhart and Rogoﬀ (2011) who draw
on national sources, and secondary sources, such as the Picks Black Market Yearbook
and the International Financial Statistics (IFS), to classify exchange rate regimes into six
types. In the order of increasing ﬂexibility, the categories are (1) no separate legal tender,
pre-announced peg or currency board arrangement, pre-announced horizontal band that isnarrower than or equal to +/-2%, and de facto peg; (2) pre-announced crawling peg, preannounced crawling band that is narrower than or equal to +/-2%, de facto crawling peg,
and de facto crawling band that is narrower than or equal to +/-2%; (3) pre-announced
crawling band that is wider than or equal to +/-2%, de facto crawling band that isnarrower than or equal to +/-5%, moving band that is narrower than or equal to +/-2%,
and managed ﬂoating; (4) freely ﬂoating; (5) freely falling; and (6) dual market in which
parallel market data are missing. We deﬁne regimes of type (1) and type (2) as a peg andthe other four types of regimes as ﬂexible.
In our model, we implicitly assume that the exchange rate peg is credible. In practice, however, non-currency-union pegs often lack credibility compared to the currency
union (Obstfeld and Rogoﬀ, 1995b).9 Historically, countries had been known to breaktheir pegs and devalue when the prices of their products were not competitive internationally. If economic agents expect such devaluations, then there are smaller incentives toalign nominal wages to the base country. In contrast, being in a currency union constitutes a credible exchange rate peg to other union members as the same currency is usedby all countries in the union and it is costly to exit the union. It is thus possible thatthese two types of pegs have diﬀerent eﬀects on wage comovements. Therefore, in many
regressions, we redeﬁne the peg regime to be the currency union and interact the currency
8
The OECD Library does not provide hourly earnings data on Greece and Switzerland, so we use theaverage annual wages to calculate wage growth rates for these two countries. Excluding them from thesample does not aﬀect our ﬁndings.
9
As Obstfeld and Rogoﬀ (1995b) mention, Eichengreen (1994), Obstfeld (1985), and Svensson (1994)
argue that ﬁxed exchange rates are inherently fragile.

24union indicator with the foreign wage growth. In such regressions, the reference group
includes countries that adopt a ﬂexible exchange rate regime and countries that engage
in non-currency-union pegs. We argue that these two types of countries are similar in thesense that ﬂexibility in exchange rate, to diﬀerent extents, is expected.
Our measure of trade intensity is the ratio of bilateral trade volume to the product√of the square roots of the GDP of the two countries, i.e., tradeHF / GDP H · GDP F .
We obtain trade volume data from the UN Comtrade dataset and GDP data from the
IFS. We measure capital ﬂow as the average of two ratios: the ratio of FDI ﬂow fromthe base country to the home country to the home GDP, and its counterpart of the basecountry.10 Similarly, migration is the average of two ratios: the ratio of migrants from thebase country to the home country to the home population, and its counterpart of the basecountry. The data on FDI and migration are obtained from the OECD Library.
To the best of our knowledge, there are no systematic data on labor productivity inthe nontradable sector, so we use labor productivity in the overall economy instead. For
country k and its base country, we obtain real output per worker from the Penn World
Table, and apply the Hodrick-Prescott ﬁlter to extract the trend components, aH
kt (z) andH (z) and αF (z), respectively.
aFkt (z), and the cyclical components, αkt
kt

The measure that we use for the term Dkt is the ratio of the CPI of tradable goods
in country k’s base country to its counterpart in country k. We construct the CPI of
tradable goods for country k, CP ITk , as
(

)(

)
k
k
CP I k − ωSk · CP ISk − ωR
· CP IR
(
)(
)
1
k
k
k
k
k
=
CP
I
−
ω
·
CP
I
−
ω
·
CP
I
S
S
R
R
k
1 − ωSk − ωR

CP ITk =1
ωTk

k are the weight of tradable goods, services, and housing in thewhere ωTk , ωSk , and ωR
k are theCPI, respectively. CP I k is the overall CPI, while CP ITk , CP ISk , and CP IR

corresponding sub-indices for tradable goods, services, and housing, respectively. When10

We do not use the geometric mean because the geometric mean becomes zero when either FDI ﬂow is
zero.

25

k are unavailable, we simply use the overall CPI as a proxy for the tradable
CP ISk and CP IR

CPI.11 The CPI data are obtained from the OECD Library.
The countries in our sample are 33 OECD members with wage data available, including Australia, Austria, Belgium, Canada, Czech Republic, Denmark, Estonia, Finland,
France, Germany, Greece, Hungary, Iceland, Ireland, Israel, Italy, Japan, Korea, Luxembourg, Mexico, Netherlands, New Zealand, Norway, Poland, Portugal, Slovakia, Slovenia,
Spain, Sweden, Switzerland, Turkey, United Kingdom, and United States.12 Because weare looking at OECD countries, the currency union is the EMU. Our sample covers datafrom 1971 to 2012. Details about the base country, episodes of exchange rate pegs, anddata range for each country are documented in Table 1. We report summary statistics inTable 2.
We use the base countries deﬁnition of Klein and Shambaugh (2006). To be speciﬁc,country k’s base country is the country to which country k pegs its exchange rate or thecountry with which country k has the most signiﬁcant trade relationship.

3.3

Main regression results

We run regressions with growth rates of nominal wages calculated over one year and four
years to check whether regression results diﬀer in the short run and in the long run as the
one-period and four-period experiments with downward nominal wage rigidity suggest.
The top rows in Tables 3 to 6 indicate the frequency of the data.
Table 3 reports the nominal wage comovements under diﬀerent exchange rate regimes.
In the odd-numbered columns, a country’s exchange rate regime is considered to be ﬁxed
if it falls into type (1) or type (2) of Ilzetzki, Reinhart and Rogoﬀ (2011). We will referto this peg deﬁnition as a general peg. For general pegs, the coeﬃcients on the interacF ) are positive, but not statistically signiﬁcant, suggesting thattion term pegkt × ∆ln(WktProposition 2 receives little support.
11

There are 11 countries for which we use the overall CPI to proxy for the tradable CPI. We conduct arobustness check that uses the overall CPI for all countries in the regression and ﬁnd very similar results.
12
The only OECD country not included in our sample is Chile due to missing data. Israel and Slovakia
joined the OECD in 2010, and excluding these two countries does not change our empirical results.

26

As discussed in Section 3.2, however, it may not be appropriate to assume that the
non-currency-union pegs and the monetary union have the same credibility and combine
them to create a single indicator variable for pegs. Given that being in the EMU is a morecredible exchange rate peg than a non-currency-union peg, we focus on the eﬀects of the
EMU and thus deﬁne an indicator variable for this type of peg, EM Ukt . It is equal to 1
if country k and its base country are both in the EMU in period t, and 0 otherwise.
We report the results associated with this EMU indicator in even-numbered columns
in Table 3. The interaction between the EMU indicator and nominal wage growth in theF ), is always positive and signiﬁcant, suggesting that beingbase country, EM Ukt × ∆ln(Wktin the EMU is associated with stronger nominal wage comovements. The magnitude of
the coeﬃcient is also economically signiﬁcant. For instance, at the annual frequency, theF ) is 1.65. It implies that if thecoeﬃcient on the interaction term EM Ukt × ∆ln(Wktnominal wages in country k’s base country increase by 1%, being in the EMU with thebase country predicts an additional increase of 1.65% in country k’s nominal wages relative
to cases where a country ﬂoats its exchange rate against the base country or engages in a
non-currency-union peg.
The interaction between trade intensity and nominal wage growth in the base country is also positive and signiﬁcant, conﬁrming the result of numerical experiments thathigher trade intensity is associated with stronger nominal wage comovements. We also
ﬁnd weak evidence for the numerical analysis result that the enhancing eﬀect of the ﬁxed
exchange rate regime on nominal wage comovements is smaller on the shorter time horizon. In the annual regression where rigidity is more likely, the coeﬃcient on the interaction
between the EMU indicator and nominal wage growth of the base country is 1.65, which issmaller than the coeﬃcient of 2.49 in the quadrennial regression. However, the diﬀerence(-0.84) is statistically insigniﬁcant. Overall, the results are largely consistent with Proposition 2 and the numerical experiments related to trade costs and downward nominal wage
rigidity.
In the regressions in Table 3, the interaction between FDI and foreign nominal wage

27

growth is always insigniﬁcant. Meanwhile, the interaction related to migration is negativeand signiﬁcant at annual frequency, which is consistent with the prediction of Dornbusch
et al. (1977) and Treﬂer (1997).
We also use all countries pairs to conduct a robustness check. The results are weakerin the sense that the eﬀect of the EMU on wage comovements is only signiﬁcant at the fouryear frequency. Because our theory involves a two-country trade model, it is suitable touse the data of countries and their main trade partners to test the theoretical predictions.

3.4

EMU countries vs. non-EMU countries

In Table 4, we repeat the estimations in Table 3 but restrict the sample to 15 countries
currently in the EMU. More speciﬁcally, the countries included are Austria, Belgium,
Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands,
Portugal, Slovakia, Slovenia, and Spain. The time range remains 1971 to 2012. The
purpose of these estimations is to check whether nominal wage comovements became
more positive during the EMU era than the pre-EMU era. Compared to Table 3, theF ) in Table 4 remains positive, and iscoeﬃcient of the interaction term EM Ukt × ∆ln(Wkthighly signiﬁcant at the quadrennial frequency.13 Hence, for the same 15 countries, there
is some evidence that the positive nominal wage comovements with their base countries
after joining the EMU are stronger than before joining the EMU. The results related to
trade intensity, FDI, and migration are similar to those in Table 3.
We also run regressions with the countries not in the EMU to examine whether noncurrency-union pegs aﬀect nominal wage comovements. The results presented in Table 5
indicate that non-currency-union pegs have no statistically signiﬁcant strengthening eﬀect
on nominal wage comovements in non-EMU countries.
13

It is close to being signiﬁcant at the 10% level at the annual frequency, with the t−statistic equal to
1.63.

28

3.5

Real wage comovements

To examine whether exchange rate regimes aﬀect real wage comovements, we repeat the
regressions in Table 3, but use real wage growth instead of nominal wage growth. The
results are presented in Table 6. The coeﬃcient of the interaction between the EMUF ), is 0.26 in theindicator and the foreign real wage growth, EM Ukt × ∆ ln(real Wkt

annual regression, and it is -3.15 in the quadrennial regression. Because both coeﬃcientsare statistically insigniﬁcant, the evidence supports the hypothesis that the exchange rate
regime should not aﬀect real wage comovements. Consistent with the results of numericalexperiments, the eﬀect of the ﬁxed regime on real wage comovements is more positive on
the shorter time horizon where it is more likely that nominal wage rigidity plays a role,
although the diﬀerence between the coeﬃcients is statistically insigniﬁcant. Meanwhile,the coeﬃcient of the interaction between trade intensity and foreign real wage growth isalways positive and signiﬁcant, lending support to the results of numerical experimentsthat a reduction in trade costs boosts real wage comovements.
When we restrict the sample to the EMU members and the non-EMU countries,
respectively, the results are very similar to those for nominal wage comovements reported
above and hence are not reported here. Overall, the evidence is generally consistent with
our model and numerical experiments.

4

Conclusions

We have constructed a Ricardian model of trade with money and trade costs and obtained
the prediction that two countries’ nominal wages must exhibit strong and positive comovements if they ﬁx the bilateral exchange rate. Meanwhile, comovements of real wages are
not aﬀected by the choice of exchange rate regime. Using numerical experiments, we havealso shown that a reduction in trade costs tends to increase both nominal and real wage
comovements regardless of exchange rate regimes. When downward nominal wage rigidity
is introduced into the numerical experiments, the strengthening eﬀect of the ﬁxed regime
on nominal wage comovements remains and is weaker on the shorter time horizon, while29

a slight diﬀerence in real wage comovements between the two regimes shows up and islarger on the shorter time horizon. We have used the data of 33 OECD countries between
1971 and 2012 to test these predictions. Based on panel regressions, we have three main
empirical ﬁndings. First, if a country and its main trade partner were in the EMU, theirnominal wages experienced signiﬁcantly stronger comovements in both the short and longrun. However, non-currency-union pegs are not associated with stronger nominal wage
comovements. Second, the eﬀect of pegs on real wage comovements is more positive in the
short run than in the long run, although statistically insigniﬁcant. Third, the larger the
trade intensity between the two countries, the stronger the comovements of both nominal and real wages. These ﬁndings are largely consistent with our model and numericalexperiments.
Our work enhances the understanding of wages in international economics in a number of ways. It adds to (1) the literature on exchange rates and wages by highlighting
the role of exchange rate regimes; (2) the literature on nominal wage comovements byshowing that ﬁxing exchange rate to a major trade partner can provide a nominal anchor
for wages; (3) the literature on the relationship between exchange rates and macroeconomic real variables; and (4) the literature on real exchange rates and the relative priceof nontradable goods.
In addition, from a policy perspective, our empirical results are also relevant for thedebate over whether the EMU is an optimum currency area. The existence of nominal
wage comovements suggests that although relative to the US, the EMU originally wasless likely to meet the criteria for an optimum currency area (Feenstra and Taylor, 2008,
p.879), it may have enhanced the economic integration of its members via nominal wage
comovements.
Finally, we note that Schmitt-Grohé and Uribe (2013) have recently found that
there were not enough downward movements of nominal wages in the Eurozone after thecrisis. It indicates that due to this downward nominal wage rigidity, the nominal wage
comovements that we have documented may not contain enough downward movements.

30Appendix A. Supplementary appendix
Supplementary appendix to this article can be found online at
http://dx.doi.org/10.1016/j.jinteco.2016.06.002.

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34

fixed regime

flexible regime

0.7

t−1

0.5
0.4

t−1

WH

WF

corr(ln( W Ht ), ln( W Ft ))

0.6

0.3
0.2
0.1
0

0

0.1

0.2

0.3

0.4

0.5

0.6

trade costs τFigure 1: Nominal wage comovements with no rigidity

fixed regime

flexible regime

0.7

t−1

0.5
0.4

t−1

WH

WF

corr(ln( W Ht ) , ln( W Ft ))

0.6

0.3
0.2
0.1
0

0

0.1

0.2

0.3

0.4

0.5

0.6

trade costs τFigure 2: Nominal wage comovements with downward nominal wage rigidity, one-period
wage growth

fixed regime

flexible regime

0.7

t−1

0.5
0.4

t−1

WH

WF

t+3
corr(ln( Wt+3
H ), ln( W F ))

0.6

0.3
0.2
0.1
0

0

0.1

0.2

0.3

0.4

0.5

0.6

trade costs τFigure 3: Nominal wage comovements with downward nominal wage rigidity, four-period
wage growth35

corrF X (∆ln(W H ), ∆ln(W F )) − corrF L (∆(W H ), ∆ln(W F ))one-period

four-period

0.7
0.6
0.5
0.4
0.3
0.2
0.1
0

0

0.1

0.2

0.3

0.4

0.5

0.6

trade costs τFigure 4: Diﬀerence in nominal wage comovements between ﬁxed and ﬂexible regimes,
with downward nominal wage rigidity: one- vs. four-period growth

fixed regime

flexible regime

0.65

t−1

0.63

t−1

0.62

t−1

0.61
0.6

t−1

W H /P H

W F /P F

corr(ln( W Ht /PtH ), ln( W Ft /PtF ))

0.64

0.59
0.58
0.57
0.56
0.55

0

0.1

0.2

0.3

0.4

0.5

0.6

trade costs τFigure 5: Real wage comovements with no rigidity

fixed regime

flexible regime

0.65

t−1

0.63

t−1

0.62

t−1

0.61
0.6

t−1

W H /P H

W F /P F

corr(ln( W Ht /PtH ), ln( W Ft /PtF ))

0.64

0.59
0.58
0.57
0.56
0.55

0

0.1

0.2

0.3

0.4

0.5

0.6

trade costs τFigure 6: Real wage comovements with downward nominal wage rigidity, one-period wage
growth36

fixed regime

flexible regime

0.65

t−1

0.63

t−1

0.62

t−1

0.61
0.6

t−1

W H /P H

W F /P F

t+3
t+3
t+3
corr(ln( Wt+3
H /P H ), ln( W F /P F ))

0.64

0.59
0.58
0.57
0.56
0.55

0

0.1

0.2

0.3

0.4

0.5

0.6

trade costs τFigure 7: Real wage comovements with downward nominal wage rigidity, four-period wage
growthone-period

four-periodF

corrF X (∆ln( W), ∆ln( W)) − corrF L (∆ln( W), ∆ln( W
))
PH
PF
PH
PF

0.01
0.008

H

0.006
0.004
0.002

F

0
-0.002H-0.004-0.006-0.008
-0.01

0

0.1

0.2

0.3

0.4

0.5

0.6

trade costs τFigure 8: Diﬀerence in real wage comovements between ﬁxed and ﬂexible regimes, withdownward nominal wage rigidity: one- vs. four-period growth37

Table 1: Summary of peg episodes and data range
Country

Base country

Episodes of non-currency-union pegs
with base country

Wage data range

EMU members (since year)
Austria (1999)
Belgium (1999)
Estonia (2011)
Finland (1999)
France (1999)
Germany (1999)
Greece (2001)
Ireland (1999)
Italy (1999)
Luxembourg (1999)
Netherlands (1999)
Portugal (1999)
Slovakia (2009)
Slovenia (2007)
Spain (1999)

Germany
Germany
Germany
Germany
GermanyUS
Germany
Germany
Germany
Belgium
Germany
Germany
Germany
Germany
Germany

1971-1998
1971-1998
1995-2010
1971-1991, 1994-1998
1971-1973, 1975-1998
1972
1971-1980, 1985-1998
1979-1998
1971-1974, 1983-1991, 1994-1998
1971-1998
1971-1998
1971-1972, 1982-1998
1994-1996, 1999-2008
1994-2006
1971-1998

1971-2012
1971-2012
2000-2012
1971-2012
1971-2012
1971-2012
1996-2012
1979-2012
1971-2012
1999-2012
1971-2012
2000-2012
1993-2012
1998-2012
1981-2012

Country in ERM II
Denmark

Germany

1971-2012

1971-2012

Other countries
Australia
CanadaCzech Republic
IcelandIsraelJapan
Korea
MexicoHungary
New Zealand
NorwayPolandSwedenSwitzerland
TurkeyUK
USUSUSGermany
Germany
US
US
USUS
Germany
Australia
Germany
Germany
Germany
GermanyUS
GermanyJapan

1971-1981
1971-2001
1993-1995, 1998-2001
1987-1999
1987-1990, 1994-2004
1972-1976
1975-1996
1971-1975, 1978-1981, 1989-1994
1995-2004
1971-1984

1984-2012
1971-2012
1993-20122005-2012
1995-2012
1971-2012
1992-2012
1980-2012
1995-2012
1989-2012
1971-2012
1995-2012
1971-2012
1991-2012
1988-2012
1971-2012
1971-20121990
1971-1991
1982-1998
1971
1971, 1991
1972-1976

Notes: (1) Prior to 1979, the UK had been the base country for Ireland, as the Irish pound had been pegged to thepound sterling. In all regressions, we discard the Irish data before 1979 to avoid complications. (2) ERM II stands
for Exchange Rate Mechanism II.

38

Table 2: Summary statistics
Mean

Standard
deviation

Min

Max

Country-year
observations

Annual change in nominal wage (%)
FlexibleNon-currency-union pegs
EMU

8.53
8.46
5.96

13.54
6.01
5.10

-5.96
0.0
-5.27

91.57
29.32
25.22

428
229
506

Annual change in nominal exchange rate (%)
FlexibleNon-currency-union pegs
EMU

3.80
2.61
0

17.47
6.61
0

-30.34-9.68
0138.63
40.55
0

428
229
506

Notes: We classify country-year observations into three categories according to exchange rate regimes: ﬂexible
regime, non-currency-union pegs, and membership in the EMU.

39

Table 3: Nominal wage regressions
Annual(1)

Annual(2)

Quadrennial(3)

Quadrennial(4)F)∆ln(Wkt-1.22(0.49)∗∗-1.15(0.48)∗∗-1.30(0.58)∗∗-1.16(0.58)∗∗

F)
pegkt × ∆ln(Wkt0.37(0.44)
0.001(0.01)pegkt
F)
EM Ukt × ∆ln(Wkt1.65(0.51)∗∗∗
0.03(0.01)∗∗EM UktF)
tradekt × ∆ln(Wkt0.27(0.49)
0.007(0.04)
2.49(0.36)∗∗∗
0.16(0.04)∗∗∗

0.26(0.08)∗∗∗
0.001(0.004)0.27(0.08)∗∗∗
0.002(0.005)0.27(0.09)∗∗∗-.01(0.03)

0.29(0.09)∗∗∗-.004(0.03)-.20(0.13)-.001(0.001)-.23(0.14)-.001(0.001)0.38(0.51)
0.03(0.03)

0.19(0.55)
0.02(0.03)-.02(0.003)∗∗∗0.000(0.001)-.02(0.06)-.03(0.05)-.02(0.007)∗∗∗-.000(0.001)-.06(0.04)-.01(0.04)-.01(0.007)0.001(0.0005)∗-.42(0.21)∗∗
0.36(0.22)-.001(0.03)
0.001(0.002)-.43(0.23)∗
0.32(0.22)H ) − ∆ln(P F )∆ln(Pkt
kt

0.20(0.11)∗

0.24(0.12)∗∗

0.65(0.37)∗

0.67(0.38)∗

F∆aH
kt (z) − ∆akt (z)0.06(0.03)∗

0.07(0.04)∗∗

0.28(0.14)∗

0.30(0.16)∗

αH
kt−1 (z)0.23(0.08)∗∗∗

0.22(0.10)∗∗

1.64(1.89)

1.60(2.06)αF
kt−1 (z)0.02(0.12)-.05(0.13)-3.93(3.06)-4.21(3.32)

Obs.
R2

1163
0.19

1008
0.21

290
0.33

261
0.35

tradekt
F)
F DIkt × ∆ln(Wkt

F DIktF)
migrationkt × ∆ln(Wktmigrationkt∆ln(ekt )∆ln(Dkt )F ) is the nominal
Notes: (1) The dependent variable is the nominal wage growth rate of country k. (2) ∆ ln(Wktwage growth rate of the base country; pegkt equals 1 if country k pegs its currency to that of its base country via
a currency union or other arrangements, and 0 otherwise; EM Ukt equals 1 if both country k and its base country
are members of the EMU, and 0 otherwise; tradekt is a measure for trade intensity between country k and its basecountry; F DIkt and migrationkt are measures for bilateral FDI and migration, respectively; ekt is the bilateralnominal exchange rate; Dkt is the ratio of the CPI of tradable goods in country k’s base country to its counterpart
H and P F are country k’s CPI and its base country’s CPI, respectively; ∆aH (z) − ∆aF (z) is thein country k; Pkt
kt
kt
kt
H
diﬀerence in the changes of deterministic components of nontradable productivities; αkt−1(z) and αF
kt−1 (z) are thecyclical components of nontradable productivities in country k and its base country, respectively. (3) The top row
indicates the frequency of the data. (4) The numbers in the parentheses are clustered standard errors that are robustto heteroskedasticity across countries and serial correlation in error terms. (5) All regressions include country ﬁxed
eﬀects. (6) *, **, and *** indicate statistical signiﬁcance at the 10%, 5% and 1% levels, respectively.

40

Table 4: Nominal wage regressions: restricting the sample to EMU countries
Annual(1)

Annual(2)

Quadrennial(3)

Quadrennial(4)F)∆ln(Wkt-.23(0.33)-.43(0.56)-.28(0.44)-.35(0.51)

F)
pegkt × ∆ln(Wkt-.22(0.48)
0.001(0.01)pegkt
F)
EM Ukt × ∆ln(Wkt0.44(0.27)
0.02(0.008)∗∗∗

EM UktF)
tradekt × ∆ln(Wkt-.44(0.63)-.003(0.06)
1.79(0.45)∗∗∗
0.14(0.03)∗∗∗

0.18(0.09)∗-.004(0.004)0.19(0.08)∗∗
0.003(0.004)0.20(0.12)∗-.02(0.02)

0.20(0.09)∗∗
0.02(0.02)-.18(0.12)-.001(0.001)-.11(0.07)-.0003(0.001)

-.65
(0.5)
-.05
(0.04)-.17(0.55)-.01(0.04)-.02(0.004)∗∗∗0.000(0.001)0.12(0.12)-.10(0.10)-.02(0.006)∗∗∗-.000(0.001)-.06(0.10)
0.04(0.11)-.02(0.009)∗∗0.001(0.001)-.02(0.40)-.001(0.38)-.04(0.02)∗-.001(0.001)-.86(0.54)
0.66(0.57)H ) − ∆ln(P F )∆ln(Pkt
kt-.06(0.10)

0.19(0.19)

0.17(0.41)

1.03(0.59)∗

F∆aH
kt (z) − ∆akt (z)0.02(0.06)-.04(0.05)

0.05(0.28)-.21(0.28)

αH
kt−1 (z)0.26(0.09)∗∗∗

0.24(0.10)∗∗

0.98(1.25)

0.60(0.98)αF
kt−1 (z)-.12(0.10)-.11(0.15)-.76(2.10)

0.74(1.22)

Obs.
R2

511
0.42

403
0.52

128
0.5

104
0.64

tradekt
F)
F DIkt × ∆ln(Wkt

F DIktF)
migrationkt × ∆ln(Wktmigrationkt∆ln(ekt )∆ln(Dkt )F ) is the nominal
Notes: (1) The dependent variable is the nominal wage growth rate of country k. (2) ∆ ln(Wktwage growth rate of the base country; pegkt equals 1 if country k pegs its currency to that of its base country via
a currency union or other arrangements, and 0 otherwise; EM Ukt equals 1 if both country k and its base country
are members of the EMU, and 0 otherwise; tradekt is a measure for trade intensity between country k and its basecountry; F DIkt and migrationkt are measures for bilateral FDI and migration, respectively; ekt is the bilateralnominal exchange rate; Dkt is the ratio of the CPI of tradable goods in country k’s base country to its counterpart
H and P F are country k’s CPI and its base country’s CPI, respectively; ∆aH (z) − ∆aF (z) is thein country k; Pkt
kt
kt
kt
H
diﬀerence in the changes of deterministic components of nontradable productivities; αkt−1(z) and αF
kt−1 (z) are thecyclical components of nontradable productivities in country k and its base country, respectively. (3) The top row
indicates the frequency of the data. (4) The numbers in the parentheses are clustered standard errors that are robustto heteroskedasticity across countries and serial correlation in error terms. (5) All regressions include country ﬁxed
eﬀects. (6) *, **, and *** indicate statistical signiﬁcance at the 10%, 5% and 1% levels, respectively.

41

Table 5: Nominal wage regressions: restricting the sample to non-EMU countries
Annual(1)

Quadrennial(2)F)∆ln(Wkt-1.48(0.64)∗∗-1.60(0.65)∗∗

F)
pegkt × ∆ln(Wkt0.06(0.55)
0.003(0.02)

0.68(0.70)-.003(0.05)

0.38(0.14)∗∗∗
0.001(0.005)0.34(0.14)∗∗-.02(0.04)-.44(0.59)
0.02(0.01)∗∗-.23(1.38)
0.22(0.09)∗∗-.01(0.01)-.000(0.001)-.04(0.05)-.04(0.05)

0.06(0.05)
0.005(0.003)-.43(0.23)∗
0.34(0.21)∗H ) − ∆ln(P F )∆ln(Pkt
kt

0.23(0.12)∗

0.66(0.38)∗

F∆aH
kt (z) − ∆akt (z)0.07(0.03)∗∗

0.37(0.16)∗∗

αH
kt−1 (z)0.22(0.13)∗

1.61(2.48)αF
kt−1 (z)0.05(0.19)-6.11(4.15)

Obs.
R2

652
0.2

162
0.36

pegkt
F)
tradekt × ∆ln(Wkttradekt
F)
F DIkt × ∆ln(Wkt

F DIktF)
migrationkt × ∆ln(Wktmigrationkt∆ln(ekt )∆ln(Dkt )F ) is the nominal wage
Notes: (1) The dependent variable is the nominal wage growth rate of country k. (2) ∆ ln(Wktgrowth rate of the base country; pegkt equals 1 if country k pegs its currency to that of its base country via a currency
union or other arrangements, and 0 otherwise; tradekt is a measure for trade intensity between country k and its
base country; F DIkt and migrationkt are measures for bilateral FDI and migration, respectively; ekt is the bilateralnominal exchange rate; Dkt is the ratio of the CPI of tradable goods in country k’s base country to its counterpart
H and P F are country k’s CPI and its base country’s CPI, respectively; ∆aH (z) − ∆aF (z) is thein country k; Pkt
kt
kt
kt
F
diﬀerence in the changes of deterministic components of nontradable productivities; αH
kt−1 (z) and αkt−1 (z) are thecyclical components of nontradable productivities in country k and its base country, respectively. (3) The top row
indicates the frequency of the data. (4) The numbers in the parentheses are clustered standard errors that are robustto heteroskedasticity across countries and serial correlation in error terms. (5) All regressions include country ﬁxed
eﬀects. (6) *, **, and *** indicate statistical signiﬁcance at the 10%, 5% and 1% levels, respectively.

42

Table 6: Real wage regressions
Annual(1)

Annual(2)

Quadrennial(3)

Quadrennial(4)F)∆ln(real Wkt-.45(0.38)-.60(0.33)∗-.70(0.56)-.64(0.64)

F)
pegkt × ∆ln(real Wkt-.28(0.36)-.01(0.03)

pegkt-.48(0.44)-.08(0.09)F)
EM Ukt × ∆ln(real Wkt

0.26(0.47)
0.02(0.04)EM UktF)
tradekt × ∆ln(real Wkt-3.15(3.17)
0.12(0.22)

0.16(0.05)∗∗∗
0.009(0.01)

0.15(0.07)∗∗
0.008(0.02)

0.23(0.10)∗∗
0.08(0.10)

0.20(0.10)∗∗
0.06(0.05)

0.004(0.04)-.001(0.003)-.002(0.05)-.001(0.003)0.45(1.04)
0.01(0.06)

0.85(1.53)
0.03(0.08)

0.003(0.002)-.000(0.001)0.15(0.16)-.16(0.15)

0.002(0.002)-.000(0.001)
0.26(0.16)-.23(0.16)-.002(0.008)-.002(0.002)1.11(0.47)∗∗-1.42(0.62)∗∗

0.003(0.04)-.001(0.003)1.11(0.34)∗∗∗-1.27(0.47)∗∗∗H ) − ∆ln(P F )∆ln(Pkt
kt-.92(0.5)∗-1.02(0.55)∗-1.98(1.06)∗-1.99(0.35)∗∗∗

F∆aH
kt (z) − ∆akt (z)-.13(0.09)-.15(0.12)-.58(0.49)-.65(0.39)∗

αH
kt−1 (z)-.51(0.16)∗∗∗-.49(0.19)∗∗∗-7.14(6.33)-6.50(4.53)αF
kt−1 (z)-.31(0.24)-.28(0.24)

4.91(8.26)

6.62(8.28)

Obs.
R2

1163
0.23

1008
0.24

290
0.34

261
0.34

tradekt
F)
F DIkt × ∆ln(real Wkt

F DIktF)
migrationkt × ∆ln(real Wkt

migrationkt∆ln(ekt )∆ln(Dkt )F ) is the real wage
Notes: (1) The dependent variable is the real wage growth rate of country k. (2) ∆ ln(real Wkt

growth rate of the base country; pegkt equals 1 if country k pegs its currency to that of its base country via acurrency union or other arrangements, and 0 otherwise; EM Ukt equals 1 if both country k and its base country
are members of the EMU, and 0 otherwise; tradekt is a measure for trade intensity between country k and its basecountry; F DIkt and migrationkt are measures for bilateral FDI and migration, respectively; ekt is the bilateralnominal exchange rate; Dkt is the ratio of the CPI of tradable goods in country k’s base country to its counterpart
H and P F are country k’s CPI and its base country’s CPI, respectively; ∆aH (z) − ∆aF (z) is thein country k; Pkt
kt
kt
kt
F
diﬀerence in the changes of deterministic components of nontradable productivities; αH
kt−1 (z) and αkt−1 (z) are thecyclical components of nontradable productivities in country k and its base country, respectively. (3) The top row
indicates the frequency of the data. (4) The numbers in the parentheses are clustered standard errors that are robustto heteroskedasticity across countries and serial correlation in error terms. (5) All regressions include country ﬁxed
eﬀects. (6) *, **, and *** indicate statistical signiﬁcance at the 10%, 5% and 1% levels, respectively.

43