Archive | September 2012

Sticky Wages

It is often said, that since we are five years into a depression, real wages should have adjusted. In the long run money is ┬áneutral. Well I am sure that the Chicago teachers were therefore willing to take a pay cut from Mr Rahm, when he logically explained that when their pay package was last discussed, inflation was expected to be at 2%, and since it has consistently undershot, the teachers are now getting 8% more purchasing power than was agreed upon, and therefore should be happy to take an 8% pay cut. If they want raises that match inflation when it is above average, they should take pay cuts when it is below average. Oh no wait. That didn’t happen. They went on strike when they didn’t get further pay rises.

This is the money illusion at work. Public employees in unionised industries can almost never take a pay cut, and as a result, the lower than expected NGDP growth/inflation, is causing funding crises in US cities. To see the scale of the problem lets look at a graph of hourly compensation (which I have shamelessly stole from Scott Sumner’s excellent blog:

Sticky wages in action

No remember, in a well functioning economy, all money spent = NGDP = all money paid out. So if wages per person do not fall in line with NGDP, there must be unemployment.


That tiny narrowing between the red and the blue line, that is wage adjustment. I also used to think that `the medium term’ when applied to wages meant about five years or so. I am revising that to twenty years or so.