This paper shows that wage volatility has significant effects on a country's rate of economic growth. Our theoretical framework suggests two distinct channels in which wage volatility affects growth: a positive direct way and a negative indirect way. The direct effect stems from precautionary savings, whereas the indirect effect works through the mediating role of government size. In the empirical part, we use a 3SLS approach to analyze a panel of 20 high-income OECD countries and find strong evidence for the existence of both effects. These results carry general and specific implications. In general, one needs to carefully consider indirect effects operating through the size of government when analyzing the effect of volatility on growth. Specific to wage volatility, our results suggest that a one standard deviation increase of volatility causes a 0.12 to 0.14 percent net increase in GDP per capita. |