Sticky Wage Theory

The sticky wage theory describes how wages tend to adjust slowly and be resistant to changes in underlying economic conditions. One explanation for sticky wages is given by the labour market search theory, which assumes that the wage bargaining set up is slowed down by search on the labour market. The equilibrium on the labour market through matching demand and supply of labour will thus take longer to achieve. In practice, nominal wage cuts do come about if companies decide not to increase annual wages or if wage increases run below the prevailing rate of inflation. Wage cuts are reserved for situations where companies are in deep distress and undergoing restructuring and are often temporary. Some governments have created workarounds to prevent unemployment during severe economic downturns. For example, under Germany’s Kurzarbeit social insurance programme, employers are able to cut employees’ working hours and pay them only for the reduced number of hours worked, thus cutting their wage bills. The government takes up some of the slack, paying them 60% (or more under certain conditions) of the wages for their unworked hours. This prevents employers from making employees redundant.