Sticky wage theory suggests that employee pay tends to resist downward changes, contributing to economic trends and job market behaviors. This theory, associated with John Maynard Keynes, highlights how wages are slow to adjust during economic shifts, impacting inflation, employment, and economic equilibrium.
What is sticky wage theory?
The sticky wage theory hypothesizes that employee pay tends to respond slowly to changes in company performance or the economy. When unemployment rises, the wages of employed workers tend to stay the same or grow at a slower rate rather than falling with decreased labor demand. Specifically, wages are often said to be “sticky-down,” easily moving up but resistant to moving down.
Understanding sticky wage theory
Stickiness is a condition where certain nominal prices resist change, applicable not only to wages but also to market prices. The aggregate price level can become sticky due to the rigidity in pricing, leading to slow responses to economic shifts. Wages, similar to prices, resist downward changes, creating a market condition of stickiness.
Although accepted by many economists, some neoclassical economists doubt the robustness of this theory. Proponents highlight reasons for wage stickiness, such as workers’ resistance to pay cuts, union contracts, and a company’s desire to avoid negative image linked with wage reductions.
Sticky wage theory is integral to macroeconomics, particularly in Keynesian and New Keynesian economics. Without stickiness, wage adjustments are slower, often resulting in job cuts instead of immediate wage reductions during economic disruptions.
Sticky wage theory in context
Sticky wages favor upward movements more than downward ones, known as “creep” or the ratchet effect. The concept of stickiness can potentially spread from one market area to another and may contribute to wage-push inflation, reducing real income’s buying power over time.
Such stickiness in wages can impact employment rates during economic downturns. In instances like the Great Recession of 2008, nominal wages remained unchanged while companies reduced employment to cut costs. Post-recession, wages and employment rates stayed relatively stagnant due to the resistance to change inherent in sticky wage theory.
Sticky wage theory and employment
During recessions, nominal wages don’t decrease due to stickiness, leading to layoffs instead of wage reductions. As the economy recovers, wages and employment remain resistant to change. Uncertainty in recognizing the end of a recession and the perceived higher cost of hiring new employees contribute to employment stickiness, leading to a hesitant hiring approach by companies.
Here is a list of the benefits and drawbacks to consider.
- Wage stability for employees
- Protection against sudden income reductions
- Employer avoidance of negative reputation due to wage cuts
- May lead to increased unemployment during economic downturns
- Reduced flexibility in adjusting labor costs for companies
- Challenges in stimulating job growth post-recession
Frequently asked questions
Why do wages resist downward changes?
Wages resist downward changes due to the reluctance of workers to accept pay cuts, potential negative repercussions for companies, and contractual agreements, such as those within unions.
Can sticky wage theory impact inflation rates?
Yes, sticky wage theory contributes to inflation by resisting downward wage adjustments, which, in turn, affects the purchasing power of real income.
Does sticky wage theory affect global economic trends?
Sticky wage theory can lead to market instability, affecting not only local but also global economic conditions, potentially influencing exchange rates and market volatilities.
Is sticky wage theory universally accepted among economists?
While widely acknowledged, some neoclassical economists question the robustness of sticky wage theory, citing potential drawbacks and limitations in specific economic situations.
- Sticky wage theory suggests that wages resist downward adjustments during economic shifts.
- Resistance to wage reductions can lead to job cuts and impact inflation rates.
- Employment and wage adjustments remain relatively stagnant post-recession due to stickiness.
View article sources
- Sticky Wages on the Layoff Margin – The University of Chicago
- Some Evidence on the Importance of Sticky Wages – Boston College
- How Sticky Wages In Existing Jobs Can Affect Hiring – Arizona State University
- 2023 Inflation Study – SuperMoney