What is the Sticky Wage Theory?

This theory, often referred to as nominal rigidity or wage stickiness, says that employee wages do not fall as quickly as company performance or economic conditions. So, if the company performs poorly or the economy performs poorly, employee wages tend to remain constant or have very slow growth. They do not generally go down with the economic downturn.

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How does the Sticky Wage Theory Work?

Wage stickiness only applies to downward trends - thus wages are stick down. This means that, generally, wages will trend upward. This is also known as wage creep. Wage creep in one job function or area is also believed to have a similar effect on other jobs or job functions. Further, the creep in wages is thought to also have effects on other aspects of the economy. Notably, foreign currency exchange rates may often overreact in an attempt to account for price stickiness, which can lead to a substantial degree of volatility in exchange rates around the world. This is known as overshooting. Wage stickiness could be based on a number of specific factors, such as difficulty in lowering employee compensation because of long-term contracts, union negotiation, employer conscience, etc. The theory of stickiness applies outside of just employee wages. It can be applied in situation where the nominal price of something is resistant to decreasing with decreases in economic productivity. In the securities trading arena, price stickiness is when stocks do not move downward commensurate with the overall economy. . Some purist neoclassical economists doubt the extent to which the theory holds true. Keynesian macroeconomics and New Keynesian economics believe that stickiness causes employment markets to be slow or never reach equilibrium, as employers cut jobs rather than reduce compensation. This distorts the effects that reducing wages without cutting jobs would have. This was evident in the 2008 recession. Stickiness also had the effect of causing employers to be slow to re-hire employees, which resulted in a sticky-up effect on employment rates.