Wages can be sticky for an awfully long time

Matt Yglesias recently made the following comments on the Chicago teacher strike:

Reading up on the Chicago Teachers’ Union strike, I note not for the first time that in the real world nominal figures, rather than so-called “real” ones, matter a great deal:

“Pay is also an issue. However, the union said the two sides are close to a pay agreement after school officials offered a deal that would increase salaries 16% over four years. The average teacher salary in Chicago was $74,839 for the 2011-2012 school year, according to the district.”

.   .   .

I take it that both sides are assuming that the Federal Reserve will persist in its policy of keeping inflation at close to but less than 2 percent per year, but there’s no guarantee of this. And yet that’s exactly how people negotiate deals””whether it’s an apartment lease or a two-year cell phone commitment or a teacher’s salary deal. We’re all enmeshed in a vast web of implicit and explicit nominal agreements, and in practice we tend to think in nominal terms.

It seems a bit weird to some people sometimes to assert that nominal shocks matter, but when you look at this kind of thing you see that it couldn’t be any other way.

People often ask me why wages have not yet adjusted to the 2007-08 recession.  I think they have, which is why unemployment has fallen from 10% to 8.1%.  But they have not yet adjusted to the NGDP shortfall of 2009-11, which is itself rather surprising.  This article helps us to understand why.  At first glance it looks like Chicago public school teacher wages are sticky for a period of 4 years, but in practice the problem is likely to be much worse.

Assume the wage agreement was negotiated on the assumption that US per capita NGDP would grow at 4% a year over time.  Then assume that actual NGDP growth was 2% (roughly the actual rate since mid-2008.)  How likely is it that the Chicago Teachers Union would come to the next negotiation with the following attitude:  “We see that our teachers got 8% bigger raises (relative to NGDP) than we anticipated or deserved.  Hence will start off the new round of negotiation with an immediate 8% pay cut.”

The problem here is that workers in safe sectors like health care have little fear of job loss, and hence have very sticky wages.  Even worse, wages in some of the most flexible sectors (such as low wage jobs), cannot be brought into line because of the recent 40% boost in the minimum wage.  Thus those workers in the remaining sectors need to accept much greater than 10% wage cuts, to make up for the 10% undershoot of NGDP.

They don’t, which is why big NGDP shortfalls create lots of unemployment.



13 Responses to “Wages can be sticky for an awfully long time”

  1. Gravatar of Kenny Kenny
    11. September 2012 at 05:54

    It’s probably even worse than you describe – is it really plausible that the teacher’s union negotiated their last (or any) wage agreement assuming *anything* about NGDP??

    This post has provided me with a nice ‘aha’ moment, as I think I now appreciate *why* stable NGDP growth is so important. I know *I* can’t feasibly (or even possibly) calculate my ‘real’ income or expenses, but it doesn’t seem much easier for anyone else, including large organizations.

  2. Gravatar of Rob Rawlings Rob Rawlings
    11. September 2012 at 06:27

    In a competitive market if an employer entered into a long term wage agreement just before a nominal demand shock that reduced the demand for his product then he would probably have to fire workers to stay in business. Competitors who were not tied to higher wages would be able to reduce costs, hire some of the fired workers and expand production at a lower price. Over a reasonable time frame (1 or 2 years) one would expect a process like this to eliminate unemployment via lower nominal wages even after a big demand shock with no need for stimulus.

    The reason that this has not happened in this recession may in part be due to minimum wages, UI , and high public sector pay. I believe however that expectation concerning monetary stimulus have themselves hampered this process.

    The reason that businesses enter into long-term wage agreements is partially due to expectations about NGDP and inflation paths. When a demand shock causes these expectations to be missed then rather than looking to increase competitiveness (by reducing costs) businesses appear to just go into a holding pattern waiting for the stimulus. Start-ups will not be motivated into activity knowing that sooner or later the CB will eliminate any tendency to falling prices that they would be looking to exploit.

    Proponents of NGDPT often present the policy as a free-market alternative to fiscal stimulus that somehow allows the economy to operate close to equilibrium through the business cycle. However is it not the case that stabilizing AD also has the effect of allowing inefficient but convenient business practices to thrive, social policies such as minimum wage to be accepted and a large and uncompetitive state sector to be indirectly subsidized?

  3. Gravatar of Nick Rowe Nick Rowe
    11. September 2012 at 07:29

    I think this is right Scott. (Though maybe, just maybe, some really big nominal shock that is widely understood as such could cause a coordinated adjustment, the currency reform being the obvious example). And yet the Calvo Phillips Curve assumes the thos prices (wages?) that can change immediately go to the new (expected) equilibrium (for that firm). There are some big supertankers out there, that can’t/don’t turn quickly.

  4. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    11. September 2012 at 07:44

    John Taylor and Russ Roberts tell it in pictures;


  5. Gravatar of Becky Hargrove Becky Hargrove
    11. September 2012 at 07:45

    Oddly enough, there is some fear of job loss for healthcare workers in the present. The schools are churning out many more hopefuls, thus it is not as “safe” for healthcare workers to attempt switching jobs as it once was. Some wages are now without benefits in the form of contract work, and there are not as many savings options with the employers as before.

  6. Gravatar of ssumner ssumner
    11. September 2012 at 09:18

    Nick, I agree.

    Patrick, Is part 2 available?

  7. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    11. September 2012 at 10:29

    Not yet, Scott. I expect to be disappointed by it when it shows up.

  8. Gravatar of Saturos Saturos
    11. September 2012 at 11:13

    People often ask me why wages have not yet adjusted to the 2007-08 recession. I think they have, which is why unemployment has fallen from 10% to 8.1%

    But didn’t most of the reduction in unemployment come from people quitting the labor force, going on disability benefits, etc?

  9. Gravatar of Major_Freedom Major_Freedom
    11. September 2012 at 11:20

    Nobody mentioned WHY wages are “sticky”: inflation psychology.

    Being born into and growing up in an inflationary economy, makes people believe prices will rise even if they don’t for periods of time.

    Inflation (whether to boost prices or NGDP) as a “solution” to sticky wages is the very reason wages are sticky in the first place.

    Dogs chasing their own tails.

  10. Gravatar of Floccina Floccina
    11. September 2012 at 11:36

    This is a really great post. I once heard a guy proclaim that the price of a gallon of milk would rise to $15 and that we would not be able to afford it anymore. So I ask him what was going to drive the price up because he might have been a peak oil or AGW or environmental doomer, but he said inflation. I said then we will be able to afford it as wages would rise. I was surprised that he accepted what I said.

  11. Gravatar of Wages can be sticky for an awfully long time « Economics Info Wages can be sticky for an awfully long time « Economics Info
    12. September 2012 at 04:00

    […] Source […]

  12. Gravatar of Greg Ransom Greg Ransom
    12. September 2012 at 12:52

    The government sector is the sticky wage sector.

    As I’ve said before.

    The government sector is the sticky price sector.

    As I’ve said before.

    The question I’ve asked before is — what is wrong with economists & “economic science” which accounts for signal fact not being standard conversation?

  13. Gravatar of Peter N Peter N
    13. September 2012 at 01:33

    But do debt payments really work as sunk costs? And what about defaults?

    Debts are pro-cyclical. If your income is reduced, when you have to pay your debts you have to cut back on other spending. This has a leverage effect and disproportionately reduces discretionary income. This was the debt service picture in 2005

    income percentile debt payments Household paying
    as % income over 40% of income
    <20 18.2 27
    20-39.9 16.7 18.6
    40-59.9 19.4 13.7
    60-79.9 18.5 7.1
    80-89.9 17.3 2.4
    90-100 9.3 1.8

    It's not hard to see what losing a job or taking a substantial pay cut would do to the families in the 40% group.

    Furthermore the possibility of losing a job makes people try harder to pay down debt.

    Debt also can be defaulted on. An actual default is a pure loss, since the debtor's relief is nominal. He never was going to repay the debt. It was a covert sunk cost, disguised by cash accounting. On an accrual basis, the money was lost when the loan became impaired. The lender will get a tax deduction, but the borrower may have to pay income tax on his "relief from debt".

    Mortgages can also be under water, which prevents the owner from being able to refinance and take advantage of lower rates or to sell the house and move to somewhere with better economic prospects. Foreclosures also are contagious, since they depress surrounding property values, which reduces equity.

    Bad debt poisons the financial system, as we've seen. People start waiting for the other shoe to drop, and they're often not disappointed. How many times has Bank of America made new loss reserves and claimed they had put the problem behind them.

    Debt problems increase the information cost of business transactions and decrease the availability of quality collateral, forcing companies to substitute money for collateral. The negative effect of these should be obvious.

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