Most private sector employment takes place in larger firms. Most larger firms use firm-level policies to set worker wages. Given the widespread use of such policies, it is worthwhile to go beyond the individual firm to consider what these policies imply for the labor market. Firm-level pay policies may help explain why wages appear to be “rigid” (meaning that wages’ response to the business cycle is limited) and why firms adjust wages only infrequently in response to changing economic conditions. These policies can also help explain why adjustments in employment and wages are asymmetric — specifically, why employment rises gradually when economic conditions improve but falls sharply as they deteriorate, and why wages are more likely to rise than fall.
This article appeared in the First Quarter 2025 issue of Economic Insights. Download and read the full issue.
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