Business Cycles Explained - Sticky Wages & Prices - YouTube

Talk about wage stickiness in a little more detail.

At first there’s a somewhat technical distinction in economics known as real wage stickiness

versus nominal wage stickiness.

Now let’s assume for the time being the price level is fairly constant, and we’ll

just assume that way.

There are few more reasons why wages might be sticky.

First, in a lot of economies, especially, say, in Western Europe, a lot of the workforce

is unionized and there is some collective contract which is enshrined in law and it

has been voted upon, and it’s very difficult to reverse the terms of that contract.

So if a lot of a labor force is unionized, for reasons of contract and/or law, those

wages will more or less automatically be sticky.

Now in the United States unions are much smaller part of the workforce, so that is one reason

but not a major reason why we have wage stickiness here.

I think in the United States the main factor behind wage stickiness really has to do with

morale and expectations.

And in my textbook with Alex Tabarrok, he and I develop what we call the parable of

the angry professor.

This actually comes from a former colleague of mine or two that I have known, and it’s

very interesting.

You’d think economists, if anyone, would react rationally to changes in their wages.

But, in fact they do not.

So if you imagine that one year a professor receives a wage cut of 2–3 percent, we have

seen empirically, I have witnessed with my own eyes, when wages are either flat or falling

for long periods of time, those professors, they become disgruntled, they complain more,

their morale falls, they don’t teach nearly as well, maybe they stop publishing, they

make trouble in departmental politics.

And those are all going back to this morale reason why a lot of wages tend to be sticky.

Now of course not everyone’s wage sticky.

Let’s say you’re a real estate agent.

You’re used to selling on commission.

You don’t expect some very fixed sum of money flowing into your checking account every

month, every year, every six months.

Your expectations are conditioned to put up with a lot of variance in income.

Or say you play poker online.

You really don’t make a very fixed plan about what you get, and in fact you can’t

control what you get.

It depends how much you win.

But nonetheless a lot of people take jobs.

They work for larger employers.

Their goal is to limit their risk to their payment stream and they make a kind of implicit

deal with the boss.

They say, you keep on paying me, I’ll keep on showing up.

I’ll work really pretty hard.

I’ll do a lot to cooperate.

I’ll do even more than really technically I’m called upon to do in the contract.

But in return I expect that I will always be valued, respected, whatever, and my wage

will not go down or not go down too much or will maybe even rise steadily over time.

And when people have those expectations, which may be valuable to build into the system ex

ante, but when the negative shock comes, and maybe some wages ought to fall, it’s often

hard to get them to fall again because of morale and this specific example which Alex

and I labeled the parable of the angry professor.

Menu Costs

Sometimes it’s not just wages that are sticky, but prices too.

Menu costs are called menu costs because of the famous example of a restaurant that needs

to print out new menus every time it wants to change its prices.

And no restaurant wants to print out new menus every day or every week or maybe not even

every month.

So what they do is they fix prices for some period of time, maybe six months or a year,

and then they just wait.

And prices in the short run often are sticky because it takes some time to adjust them

and consumers often don’t like the price bouncing around a lot, and that’s called

menu costs.

It is another part of the Keynesian argument.