Question

1.Policy Topic: We have a recession. What do I need to know about “sticky wages?”

Explain the concept

Describe and analyze all of the theories cited about why wages might be “sticky.”

How do “sticky” wages play a large role in policy effectiveness?

How does this concept change the policy approaches of Keynesians and Classicalists?

Answer 1

1. The sticky wage theory states that the pay of the employed workers responds slowly to the change in the performance of the economy as a whole. The wages can move up easily but move down with difficulty and thus wages are sticky.

2.The sticky wage theory is given by Keynes and new Keynesian economists like Mankiw. They state that the wage agreements are signed before and they remain for a minimum period of one year. During this time any change in the economic performance of the economy cannot change the wage agreed upon earlier between the union and the employers. The contract is signed before and does not change.

3.This leads the way for government interference in the economy to control the economic activity as wages will not change automatically and are not flexible and thus government will have to intervene to move the economy to its potential level. in case of flexible wages, markets adjust automatically without government interference.

4. Keynes believed in sticky wages and thus states that government interference in the form of fiscal policy is needed to move the economy out of recession. On the other hand, Classical believed in flexible wages and interest rates and thus advocated laissez faire policy with no government interference and markets will move the economy automatically to its potential level.