Wage stickiness is market failure. So why are we not correcting it?

Scott Sumner has a gift for inspiring revelation. He says:

The W/NGDP ratio shot up in 2009, and unemployment soared. Since then the ratio has come part way back to trend, and the unemployment rate has come part way back to trend. We have excellent data showing George Selgin’s example is common, wage increases bunch around zero percent. Until we get a more plausible theory of unemployment, I’m sticking with stickiness.

I believe this is what he was talking about.

In 2008, NGDP fell rapidly. If average hourly compensation did as well, the ratio would have been the same. We’ve come a long way to adjusting back to trend, but this graph is striking nevertheless.

In 2008, employers were faced with a decision: slash compensation across the board or fire people. Being averse to spreading the pain (for cognitive and practical purposes), they fired people. And that shows you how crucial timely and aggressive anti-cyclical policy has to be. Because the poor souls who were laid off in 2008 were relatively powerless, but they were insiders. Now they’re outsiders. It’s become an incumbents/entrants game. If Susy wasn’t willing to take a pay cut in 2008 to protect Bobby’s job even though they worked together and discussed each others kids often, Susy is going to be less interested in a pay cut to hire Jerry who she doesn’t know. That’s assuming the rosy and unrealistic picture that firms haven’t done the aggressive cost-cutting needed in the past four years to squeeze more productivity out of the remaining employees and thus reducing the firm’s overall employment needs.

This is market failure. The market has collectively decided wage stickiness is worth the monumental cost to society. It’s not. That is the clearest sign that public institutions should act. GDP growth is the side of this equation that must be targeted. What institution should act, though? Coincidentally, employment and GDP growth are THE two things the Fed is charged with targeting. A martian who came here would be able to study our institutions for an hour and come up with the answer.

You would think Scott Sumner’s blog would get banal given its singular and incessant focus. It demonstrates, however, that every angle from which light can be cast on the great injustice being perpetrated against humanity today by public leaders makes it clearer and more distinct still.

On a final note, when people look back with astonishment at how the Fed consistently undershot its targets and — with the support of a majority of economists — nevertheless resisted helping society, I hope the blogosphere gets some credit. Dismal science indeed.


Commenter Mark Sadowski, who is better versed in this data than I am points me to this graph with a slightly different data series.

It shows we aren’t as far back to trend as we might think. It also shows just how much wage stickiness is built into unemployment.


6 thoughts on “Wage stickiness is market failure. So why are we not correcting it?

  1. Keeping people on the payrolls when there is nothing to do seems like a waste in any sense of the word, and demand did decrease… see for example http://logistics.about.com/b/2009/02/18/the-word-of-the-day-is-destocking.htm

    Instead of paying people to work the same number of hours despite having nothing to do, businesses could have just rewarded people who chose to reduce their hours and take a small pay cut—similar to what Germany did but without government involvement. This would have reduced the income of workers but also their work obligations, and since most people were willing to take a pay cut there is little reason to think this wouldn’t have worked.

    The real market failure is the economics profession and their lack of support for this solution while unemployment remains high. [link removed due to spam filter, anyone interested can refer to comment on previous post]

    The Fed is supposed to prevent unemployment and inflation, not increase employment and GDP growth.

  2. .”We’ve come a long way to adjusting back to trend, but this graph is striking nevertheless.”

    The problem is that we have not.

    One needs to correct this for population growth. Furthermore the more commonly used wage series (and the one with a longer history), Average Hourly Earnings of Production and Nonsupervisory Employees (AHETPI) has been even stickier.

    Graphing AHETPI/NGDP per capita and plotting it alongside the unemployment rate shows that the two have a rather close correspondence:


    So the solution is obviously to raise NGDP which ultimately is the job of the Federal Reserve.

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