What is the Sticky Wage Theory?This theory, often referred to as nominal rigidity or wage stickiness, says that employee wages do not fall as quickly as company performance or economic conditions. So, if the company performs poorly or the economy performs poorly, employee wages tend to remain constant or have very slow growth. They do not generally go down with the economic downturn. Show Back to:ECONOMIC ANALYSIS & MONETARY POLICY How does the Sticky Wage Theory Work?Wage stickiness only applies to downward trends - thus wages are stick down. This means that, generally, wages will trend upward. This is also known as wage creep. Wage creep in one job function or area is also believed to have a similar effect on other jobs or job functions. Further, the creep in wages is thought to also have effects on other aspects of the economy. Notably, foreign currency exchange rates may often overreact in an attempt to account for price stickiness, which can lead to a substantial degree of volatility in exchange rates around the world. This is known as overshooting. Wage stickiness could be based on a number of specific factors, such as difficulty in lowering employee compensation because of long-term contracts, union negotiation, employer conscience, etc. The theory of stickiness applies outside of just employee wages. It can be applied in situation where the nominal price of something is resistant to decreasing with decreases in economic productivity. In the securities trading arena, price stickiness is when stocks do not move downward commensurate with the overall economy. . Some purist neoclassical economists doubt the extent to which the theory holds true. Keynesian macroeconomics and New Keynesian economics believe that stickiness causes employment markets to be slow or never reach equilibrium, as employers cut jobs rather than reduce compensation. This distorts the effects that reducing wages without cutting jobs would have. This was evident in the 2008 recession. Stickiness also had the effect of causing employers to be slow to re-hire employees, which resulted in a sticky-up effect on employment rates. Related Topics
KEY POINTS:
I. Economic activity fluctuates from year to year.
II. Three Key Facts about Economic Fluctuations
III. Explaining Short-Run Economic Fluctuations
IV. The Aggregate-Demand Curve
V. The Aggregate-Supply Curve
(A new computer chip would not be sufficient to shift the LRAS) As a result, it has shifted the long-run aggregate-supply curve to the right. b. Opening up international trade has similar effects to inventing new production processes. Therefore, it also shifts the long-run aggregate-supply curve to the right. E. Why the Aggregate-Supply Curve Is Upward Sloping in the Short Run
VI. Two Causes of Recession
VII Monetary Policy VIII Fiscal Policy A. Government Purchases B. Reduction in Taxes More Monetary Policy Banks and the Money Supply A. The Simple Case of 100-Percent-Reserve Banking 1. Example: Suppose that currency is the only form of money and the total amount of currency is $100. a. Definition of reserves: deposits that banks have received but have not loaned out. 2. The financial position of the bank can be described with a T-account:
a. Before the bank was created, the money supply consisted of $100 worth of currency. b. Now, with the bank, the money supply consists of $100 worth of deposits. Definition of reserve ratio: the fraction of deposits that banks hold as reserves. c. Now First National decides to set its reserve ratio equal to 10% and lend the remainder of the deposits. The bank’s T-account would look like this:
When the bank makes these loans, the money supply changes. Now, after the loans, deposits are still equal to $100, but borrowers now also hold $90 worth of currency from the loans. 1. The creation of money does not stop at this point. 2. Borrowers usually borrow money to purchase something and then the money likely becomes redeposited at a bank. 3. Suppose a person borrowed the $90 to purchase something and the funds then get redeposited in Second National Bank. Here is this bank’s T-account (assuming that it also sets its reserve ratio to 10%):
4. If the $81 in loans becomes redeposited in another bank, this process will go on and on. 5. Each time the money is deposited and a bank loan is created, more money is created. The Fed’s Tools of Monetary Control 1. Definition of open market operations: the purchase and sale of U.S. government bonds by the Fed. a. If the Fed wants to increase the supply of money, it creates dollars and uses them to purchase government bonds from the public in the nation's bond markets. b. If the Fed wants to lower the supply of money, it sells government bonds from its portfolio to the public in the nation's bond markets. Money is then taken out of the hands of the public and the supply of money falls. c. If the sale or purchase of government bonds affects the amount of deposits in the banking system, the effect will be made larger by the money multiplier. d. Open market operations are easy for the Fed to conduct and are therefore the tool of monetary policy that the Fed uses most often. 2. Definition of reserve requirements: regulations on the minimum amount of reserves that banks must hold against deposits. a. This can affect the size of the money supply through changes in the money multiplier. b. The Fed rarely uses this tool because of the disruptions in the banking industry that would be caused by frequent alterations of reserve requirements. 3. Definition of discount rate: the interest rate on the loans that the Fed makes to banks. a. When a bank cannot meet its reserve requirements, it may borrow reserves from the Fed. b. A higher discount rate discourages banks from borrowing from the Fed and likely encourages banks to hold onto larger amounts of reserves. This in turn lowers the money supply. c. A lower discount rate encourages banks to lend their reserves (and borrow from the Fed). This will increase the money supply. d. The Fed also uses discount lending to help financial institutions that are in trouble. How do sticky wages affect aggregate supply?According to the sticky-wage theory, the short-run aggregate-supply curve slopes upward because nominal wages are slow to adjust to changing economic conditions. In other words, wages are “sticky” in the short run.
What is the theory of sticky wages?In short, sticky wage theory says that nominal wages respond slowly with downward rigidity to negative changes in performance of a company and the broader economy largely because workers are reluctant to accept cuts in nominal wages.
What is sticky wage model of aggregate supply?The sticky wage theory is an economic concept describing how wages adjust slowly to changes in labor market conditions. Unlike other markets where prices are dictated by supply and demand, wages tend to remain above equilibrium as employees resist wage cuts.
Why do sticky wages and prices increase the impact of an economic downturn on?Sticky wages and prices amplify the effects of economic downturns because when a recession occurs, salaries remain unchanged, causing prices to remain high. Employers can no longer afford to keep workers as a result, and workers lose their employment as a result.
|