Wages and recovery: A note

There seems to be some hatred for the idea that if nominal wages were more flexible unemployment would not rise as high (here, here, and here).

However, I am a fan of the flexibility argument – and not just because my mind struggles to get outside of partial equilibrium 😉

When I view wage flexibility I think about it in THREE ways that would lead to an improvement in outcomes – in so far as they would reduce the “market failure” that leads to a “surplus of labour”.  These are both RELATIVE PRICE arguments:

  1. Wages relative to substitute inputs:  Wages need to be able to adjust more quickly than other inputs.  If this is the case then employers would cut back on other inputs ahead of labour.  Given that there is both substitutability and complementarity in inputs this is a difficult issue – but nonetheless.
  2. Wages relative to goods:  Wages need to be able to adjust more quickly than goods prices.  That way real wages will decline, making labour relatively cheaper.
  3. Relative wages:  This is the big one for me.  Often during a recession there may need to be a reallocation of labour resources, or there may be uneven shifts in demand for types of labour.  If relative wages can adjust then we ensure that the cost (in terms of climbing unemployment and general economic inefficiency) can be minimised.