What Is the Sticky Wage Theory?

What Is the Sticky Wage Theory?

Let me explain the sticky wage theory directly: it hypothesizes that employee pay doesn't adjust quickly to shifts in company performance or the broader economy. When unemployment climbs, the wages of those still employed tend to hold steady or increase slowly, rather than dropping with reduced labor demand. You'll often hear wages called 'sticky-down'—they go up without much fuss but resist going down. This idea comes from economist John Maynard Keynes, who termed it 'nominal rigidity' of wages.

Key Takeaways on Sticky Wages

Here's what you need to grasp: sticky wage theory claims pay resists decline even when the economy worsens. Workers push back against cuts, so firms cut costs elsewhere, like through layoffs, when profits drop. Real wages get worn down by inflation instead of direct reductions. This 'stickiness' appears in other areas too, such as prices and taxes, and it's a cornerstone of Keynesian economics.

Understanding Sticky Wage Theory

Stickiness refers to a market condition where nominal prices resist change. It applies to wages but also to prices in general, often called price stickiness. In markets, the average price level can become sticky due to uneven rigidity—prices flex upward easily but not downward. This means they won't drop quickly during economic downturns as they should. You see, people accept raises happily but fight pay cuts, and that's how wages behave too.

Many economists accept wage stickiness, though some neoclassical purists question it. Reasons include workers' preference for raises over cuts, union contracts that lock in pay, and companies avoiding the bad publicity of wage reductions. In macroeconomics, especially Keynesian and New Keynesian models, stickiness matters. Without it, wages would adjust in real-time, maintaining equilibrium with minimal job loss. But with stickiness, disruptions lead to employment cuts rather than wage drops, slowing market recovery.

Sticky Wage Theory in Context

Consider this: sticky wages favor upward changes over downward ones. Wages trend up more often, creating 'creep' or a ratchet effect. Some economists say stickiness spreads across markets, from one sector to others. But remember, it's somewhat illusory—real buying power erodes via inflation, known as wage-push inflation. Competition for jobs can make stickiness contagious, as firms keep wages competitive.

On a global scale, stickiness affects things like currency exchange rates through 'overshooting,' where rates overreact to price rigidity, causing volatility.

Sticky Wage Theory and Employment

Employment gets distorted by sticky wages. During a recession, like 2008's Great Recession, nominal wages didn't fall—they stuck. Companies laid off workers to save costs without cutting remaining pay. As recovery starts, both wages and hiring remain sticky. Firms hesitate to hire because it's unclear when the recession truly ends, and new hires can cost more short-term than slight raises. So, post-recession, employment might be 'sticky-up,' while surviving employees often get pay increases.