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Abstract

This paper tests the morale theory of nominal wage rigidity, according to which firms resist making nominal cuts to workers’ pay even in adverse economic conditions because such cuts hurt worker morale and productivity. The authors analyze data from an employer-employee survey they conducted in Japan in 2000. That year coincided with a rare spell of deflationary recession, which, the authors argue, is a good setting in which to study how nominal pay cuts affect morale. They find that a nominal annual pay freeze, experienced by 21% of the sampled workers, demoralized workers by reducing their trust in the firm, and that even greater demoralization—not wholly attributable to reduced trust—was associated with a nominal pay cut, which affected 17% of the workers. The observed negative relationship between nominal pay cuts and morale persists even when the estimation includes controls and firm fixed effects.

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