Basil Halperin wrote a great piece a couple weeks ago on why we should use sticky wages. I have couple thoughts on the “reasoning” behind sticky wages, and their implications.
Are Sticky Wages a Good Approximation?
The central question I now have about sticky wages is whether or not they are a good approximation of the general behavior of wages in a recession. Are wages consistently variable as implied by the idea of sticky wages? No. So what do sticky wages represent?
One explanation, mentioned by Halperin, is that new hire wages can be sticky. This makes more sense, as those wages are completely variable. This could also apply to workers seeking promotions or renewals of contracts. In fact, the “wage rigidity is contract rigidity” view is the one I personally prefer. Essentially, wages aren’t sticky “because you were “too stupid and too stubborn” to lower your wage demand”,1 they’re sticky because you can’t adjust a rigid contract.
The contracts view does also apply to sticky prices, as companies facing contracts may have cashflow shortfalls if NGDP drops. In that case, real wages would rise, causing unemployment and industrial malaise.
Because of the Implication
The main implication of all the causal scenarios I discussed is simple: target nominal income. The source of distortion is an NGDP shock.
It also implies that equilibrium wages are a function of NGDP. Essentially, that it’s cash balance, not productivity, that manages real wages. This means that growth slowdowns must be met by loose money. That lesson implies that policy since Volcker has erred tight, and that 1970s policy erred loose.
From the Halperin piece