How would we know if wages were sticky?
By Scott Sumner
I’ve done a lot of posts on wage stickiness, but misconceptions keep popping up. The sticky wage theory of the business cycle is based on the notion that only a fraction of wages get adjusted each period. This leads to some odd results. The bigger the fall in the equilibrium wage rate, the bigger the fall in the actual wage. That’s no big surprise.
But what does seem to surprise people is that the bigger the fall in the equilibrium wage, the more that actual wages exceed equilibrium wages. That means that, according to the sticky wage theory, during periods where wages fall most the rapidly, we should expect to see the highest rates of unemployment. The same is true regarding cross sectional data.
Thus suppose that Nevada was hit by a severe real estate collapse, and its equilibrium wage fell by 10%. Also suppose that at the same time Texas was buoyed by an oil boom and its equilibrium wage rose by 4%. Finally, assume that due to sticky wages, the actual wage only moves by 1/2 of the amount that the equilibrium wage moves, in a given period. In this example, Nevada’s actual wages would fall by 5% and therefore end up 5% above equilibrium, leading to mass unemployment. Texas wages would rise by 2% and end up 2% below equilibrium, leading to a tight labor market.
Now consider this example, when reading the following comment by Arnold Kling, who is discussing some research by Erik Hurst:
The facts are real wages moved very strongly with employment across regions. Nevada was hit very hard by the recession, for example, while Texas was hit much less hard. Wage growth, both nominal and real, was about 5 percent higher in Texas than it was in Nevada during the Great Recession.
Pointer from Tyler Cowen.
The point is that we do not have a single aggregate economy. If you think that every state faced identical demand conditions, then the state with the higher real wage growth (Texas) should have had the worse unemployment. And Hurst goes on to point out how the regional data make it difficult to defend the view that wage stickiness is the cause of unemployment.
Actually, that’s exactly what you’d expect if sticky wages caused business cycles. And for similar reasons, interest rates tend to be at their lowest when they are the furthest above the Wicksellian equilibrium interest rate.