Wage Dynamics and Volatility Persistence in a War-Era Labor Market

Abstract This paper investigates wage volatility and unemployment dynamics in the German labor market during World War I, with a focus on understanding the stability of wages and the increasing trend in expected wages over time. Using a Fractionally Integrated Generalized Autoregressive Conditional Heteroskedasticity (FIGARCH) model, we find that wage volatility exhibits long memory, suggesting that historical shocks, particularly those related to the war effort, had enduring impacts on labor market dynamics. Our empirical analysis reveals that while actual wages remained relatively stable, the expected wages increased over the war period, reflecting workers' optimistic outlook about future wage growth. To address the observed labor market trap—characterized by the interplay between voluntary unemployment and wage rigidity—we propose a novel approach based on optimizing productivity forecasts. This method involves recalibrating productivity estimates to escape the market's stagnation, enhancing the labor market's response to shifts in supply and demand. Our results contribute to the broader literature on wartime labor markets by providing insights into wage stability mechanisms and offering a practical solution to overcome labor market traps during periods of economic disruption. JEL Classification. N34, J31, C22, E24