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Source link: http://archive.mises.org/15489/are-sticky-wages-a-market-failure/

Are “Sticky Wages” a Market Failure?

January 31, 2011 by

Is it really such a stretch to suppose that when the US government (and Federal Reserve) brings the economy closer to outright socialism — as with Hoover, FDR, Bush, Obama, and Bernanke — that those very interventions hamper the economy? FULL ARTICLE by Robert P. Murphy

{ 74 comments }

Thomas L. Knapp January 31, 2011 at 9:46 am

“Someone making $20 per hour today, might make only $8 per hour tomorrow. In such an environment, workers would build up an enormous cushion of savings, because they would have to draw down their liquid assets to get them through periods of below-average wages. Very few workers would buy houses, but would instead rent apartments, ideally on month-to-month terms.”

I’m not sure that last is obvious. All other things being equal (stability of employment, average income over the long term, the existing web of subsidies for home ownership, etc.), it seems at least as likely that mortgage providers would come up with variable payment models — your income goes up or down, so does your mortgage payment.

Matter of fact it seems more likely that mortgage providers would be able to so adjust to constantly shifting pay than rental landlords would be. Mortgage providers would at least have complete payment over time “locked in,” while rental landlords would be up against the problem of “if I rent low to this guy while his pay is low, is he going to stay when it goes up?”

Dave Albin January 31, 2011 at 10:46 am

That’s what I thought as well.

Nick Bradley January 31, 2011 at 5:09 pm

Kn@ppster,

Are any of the exotic mortgage products you discuss really necessary? Last I heard, millions of entrepreneurs with unsteady and unpredictable streams of income buy houses all the time.

Artists, actors, pro golfers, and tons of other professions tend to rent until they can buy a property in cash. It may not be optimal in an inflationary system, or in a system where we subsidize home mortgage interest, but it works.

Thomas L. Knapp January 31, 2011 at 6:05 pm

Nick,

The “exotic mortgage products I discuss” might not be necessary. But they already exist in some forms (variable payments, insurance to cover during unemployment/disability, etc.) if the market was there for more robust versions, they’d presumably emerge.

Anyway, my main point was just that it’s not obvious that “unsticky” wages would militate against home ownership and for rental.

Captain_Freedom February 1, 2011 at 7:50 am

Murphy isn’t saying home ownership would be eliminated, he said that very few workers would buy houses if their wages greatly fluctuated from minute to minute, day to day.

It’s completely obvious that the number of workers owning homes would drastically decline. Mortgage lenders would lend LESS to mortgaged loan borrowers if the income stream from their lending were more volatile. The more volatility there is in an income stream, the more risky the underlying security, and the more risky the security, the lower the price (lower quantity of lending). From the borrower side, a worker who earned highly volatile wages would be less willing to commit to rigid interest obligations, of which mortgages are composed.

james b. longacre February 1, 2011 at 12:19 am

I’m not sure that last is obvious. All other things being equal ….that doesnt happen though, right? ever??

Captain_Freedom February 1, 2011 at 7:45 am

“…it seems at least as likely that mortgage providers would come up with variable payment models — your income goes up or down, so does your mortgage payment.”

HIGHLY unlikely.

Suppose I am in a relationship and I have a relatively low paying job. I own a house under my name. Suppose my partner gets a raise. I quite my job, and pay zero mortgage payments.

What mortgage lender in their right mind would offer such a mortgage?

The fact that such contracts are not at all prevalent today should be strong evidence against it.

Nick Bradley January 31, 2011 at 10:07 am

Yet another great article. You hit the nail on the head when you said that employers and employees prefer long-term, stable labor contracts for predictability. These contracts are written on their assessment of demand for consumer and capital goods — when that picture is distorted due to government intervention, the contracts need to be “torn up”…layoffs and unemployment.

You didn’t discuss it, but wages would be less sticky if we had an even more flexible labor market. Now, the US has the most flexible labor market in the OECD, but what if we actually had free trade in labor? With a robust guest worker program, cheaper labor could come in and work pretty quickly; as the economy grows, new opportunities will arise for the displaced workers. Increased domestic labor mobility would also reduce the “stickiness” of wages.

http://crwl.blogspot.com/2011/01/case-for-open-borders.html

matt470 January 31, 2011 at 10:18 am

Great article thanks Dr Murphy.

I haven’t read Smith’s full article but from the excerpts in Bob’s article I would say that Smith commits a logical fallacy (ignoratio elenchi) by saying…

Many smart commentators still see recessions as either a calamity akin to a crop failure or as punishment for excesses. If that was what a recession was then the result should be our working harder to overcome the calamity or make up for our excesses.

If a recession is akin to a crop failure… where is his justification that a crop failure is either overcome or prevented by harder work? I work in agriculture and I would say the chance of crop failures can be reduced or the risk offset by working smarter but rarely is the answer to just work harder.

It is also a non sequitur to say that the only way to overcome “excesses” is to work harder. There are any number of examples of excesses that simply wouldn’t be overcome by harder work… what about the “excess” of being a work-aholic for example? As Dr Murphy well explains (and as others such as Mises have before him), if work is being committed on the wrong projects then working harder at them is only going to result in a less productive outcome. An example may be digging ditches and filling them in again, or from a more Austrian Business Cycle theory, expending resources on long-term capital projects that consumers do not really value high enough to make the necessary savings from current consumption expenditures to provide the capital for (central bank artificially lower interest rates).

ABR January 31, 2011 at 10:23 am

I like von Mises’s metaphor. Smith’s approach makes as much sense as ‘intelligent’ design.

Sticky wages: are they the result of natural market factors or the result of government intervention? An employer would never want to pay an employee to do nothing. The supply of employees would have to be weak in comparison to demand, for employers to agree to steady wages, imho.

In the complete absence of govt. intervention, employees might bid for tasks required by entrepreneurs within the company. In this case, risk on wages would be limited to the task.

james b. longacre February 1, 2011 at 12:20 am

“Sticky wages: are they the result of natural market factors or the result of government intervention? ”

what is a sticky wage anyway?? do prices for some goods also have a sticky ( as you claim) quality??

do layoffs reflect the non sticky ness of wages??

Blackadder January 31, 2011 at 11:03 am

Bob,
You make a good point about why it is rational for workers and employers to want sticky wages. But don’t you see that this undercuts your arguments against Mankiw/Smith et al? Their argument is that sticky wages impede the adjustment process to a monetary contraction. Your response was that the only reason we have sticky wages was because of gov interventions like unemployment benefits. If wages would be sticky even in a purely free market, then your response to Mankiw/Smith fails and their point stands.

Matthew Swaringen January 31, 2011 at 3:11 pm

Their point doesn’t stand unless one assumes inflation of the money supply is something that will bring about a sustainable restoration of employment.

The point that wages are sticky does stand, but I don’t know that any Austrian claims that recessions aren’t painful and won’t have any period of unemployment. These periods are extended due to some government interventions (unemployment compensation, regulations that prevent new business, etc) and some wages are stickier than they otherwise would be due to unions/minimum wages, etc.

Captain_Freedom February 1, 2011 at 7:52 am

Blackadder,

No Austrian, including Bob, claims that wages would “instantly adjust” in a free market, nor would they argue that the “only reason” wages are “not infinitely flexible” is because of government intervention. There is nuance here.

When Bob et al respond to quasi-monetarists who argue that “wages are sticky, therefore the government needs to inflate”, they are saying that wages will adapt to the new monetary conditions as market forces bring them down. Free market forces won’t bring wages down in the way interventionists pejoratively claim that straw man Mr. Market insists must happen in a free market, and if they don’t instantly adjust across the board, then it’s inflation time!
What Austrians are saying is that *to the extent* that wages are inflexible due to government intervention, this causes widespread unemployment where there would otherwise be less unemployment. Austrians are NOT saying that without government intervention, wages would adjust instantly a la “pure and perfect competition” every minute of every day.

Yes, if there is a decline in aggregate spending and that decline results in a concomitant decline in the money demand for labor, then to the extent that the free market generates wage contracts that are not “infinitely and instantly flexible” according to the straw man free market model of “pure and perfect competition”, then there will be unemployment. But this fact does not imply that governments have to use violence and force aggregate demand to move away from where it would move with individual economic freedom. Such interventions would only *exacerbate* the wage inflexibility, because inflexible wage contracts that market forces would otherwise punish, end up get rewarded as if people voluntarily found them as valuable as they seem to be in the interventionist world.

In fact, if it weren’t the case that unemployment results during an economic downturn, then the whole Austrian theory would be a wash.

You are fallaciously claiming that Austrians hold wages to be infinitely flexible as they are in the “pure and perfect competition” model.

If our monetary system were free market driven, then the supply of money and hence spending would be much more stable over time compared to an economy where there is a single monopoly of money producers whose mistakes affect everyone. As such, to the extent that wages become “rigid” compared to “pure and perfect” pricing, it would be justified, and if the government made the inflexibility more pronounced by intervention, then the unemployment that results cannot be blamed on the market.

In other words, no Austrian is claiming that unemployment would always be zero in a free market because prices allegedly adjust instantly. What they are saying is that those interventionists who so often complain about “sticky wages” rarely, if ever, show understanding that the very same government that they call on to solve the “sticky wages” problem, is itself exacerbating wage rigidity beyond what is justified according to individual preferences in free trade.

To Austrians, wage “stickness” is considered absent in a free market, because in the real world of mankind, where nothing operates according to any mystical standard of “pure and perfect competition”, wages are necessarily as flexible as they can possibly be, for they are the result of maximal individual reason and voluntary choice.

It is almost impossible for an interventionist to understand this nuance, because they come to the table as philosophically very hostile to individual choice, and therefore deny the notion that free individual choice maximizes utility/prosperity/progress/employment/etc/etc. They come with prejudice right off the bat, and they rationalize this antagonism by making all sorts of claims that they are not really hostile to the free market, they are only trying to get the free market to act like it “should” in “pure and perfect competition/pricing”.

Interventionists think very much like an abusive parent or guardian thinks. They rationalize their abusive behavior by claiming that they do so only because their children do not act so “perfect” like the non-abusive parents allegedly claim would take place absent the abuse. So they abuse the children to “save them from themselves”, and to force them to act “perfect” like all those pesky parents claim will happen in a peaceful household.

Just like parents who do not beat their children are not saying that peace will turn children into angels, so too do Austrians tell interventionists that removing the regulations will not make wages perfectly flexible.

Market determined “wage inflexibility” is, to the Austrian, a rather ephemeral, curious concept, because it implies that freedom of association and peaceful trade does not live up to a standard interventionists claim it must, or else they will bring out the guns and impose “perfection” by force (of course with failure, but interventionists don’t really care, and say, incredibly, “Yeah, well, government isn’t perfect.”

You have to be very careful in what the Austrian position really is. It is NOT “pure and perfect competition”. That is a straw man standard devised by interventionists to justify government intervention. Intellectuals with a psychological predisposition of wanting to control other people often rationalize prior acts of mindless government violence by creating new sophisticated theories that supposedly justify the violence.

This is what quasi-monetarists do with central banking. Central bankers and government created central banking by threatening everyone with violence into using their paper as money, in order to allow them to continue to misappropriate demand deposit money, and continue to inflate money out of thin air and earn profits on that money created out of thin air. Intellectuals with a psychological bent on social control, e.g. quasi-monetarists, rationalize this violence by inventing theories on aggregate demand and its supreme importance on everything economics related.

First they say that if the government didn’t inflate and spend, then the rate of profit would continually fall until it hits zero. That was already proven false by the time it was advanced, so the interventionists came up with a new justification, which is that without inflation, unemployment would result because savings would leak out of the economy. Then they invented “wage stickiness” to justify inflation.

They keep coming up with new rationalizations to justify the violence underpinning the whole thing. The reason why the justifications for inflation, and central economic planning in money production backed by violence, keeps changing, is because *there is no rational justification for violence*.

Many intellectuals see violence around them, and rather than questioning it and fighting back, they just don’t want to question the violence, and they start to do what every abused child does: they start to question themselves as rational actors capable of surviving and prospering in peace.

There has been dozens of justifications for violence backed inflation, each new justification as absurd as the last justification. The latest fad is blaming wages and prices as not living up to an impossible standard of flexibility.

It’s easy to blame the free market and justify violence when you hold the free market up to an impossible standard.

I should create a “pure and perfect government” standard, whereby all governments should be measured up against it, and if they fail to live up to it (infinitely flexible tax rates, infinitely flexible immigration/emigration, infinitely flexible rules and regulations, infinitely flexible democratic voting for every single law proposed, infinitely flexible competition in public services, infinite number of governments, no one government controlled society can appreciably affect the rules and social mores of any other government controlled society, etc, etc, etc), and then, when the governments of the world inevitably “fail” to live up to this standard, declare that governments must not have any unilateral power at all, and that the market must regulate violence and hence provide all protection and security services. Anyone who defends government must be dogmatists because they fallaciously and ignorantly believe that governments act pure and perfect, and that taxes and inflation are infinitely flexible and must instantly respond to social conditions every minute of every day.

Blackadder January 31, 2011 at 11:25 am

Also, while I don’t want to get off on too much of a tangent, but the attempt to pin high unemployment during the early years of the Great Depression on Hoover’s pleas not to cut wages strikes me as deeply unpersuasive. In any other context Austrians would snicker at the idea that the government could impede normal market processes simply by using moral suasion. Hoover’s unemployment conference was the equivalent of the Ford people wearing WIN buttons, but apparently the man was so persuasive that he managed to keep all employers (not just those at the conference) from cutting wages for years, even to the point that you had 25% unemployment.

Matthew Swaringen January 31, 2011 at 3:08 pm

Why do you think they didn’t lower wages?

Blackadder January 31, 2011 at 10:13 pm

It’s not that easy to cut wages. Employees resent it and the transaction costs are high. You’re usually better off laying people off (a laid off worker might resent you too, but he’s no longer around so it doesn’t matter so much).

Captain_Freedom February 1, 2011 at 8:45 am

It’s not easy because workers and employers have become so conditioned to expect gradually rising prices over time due to the Fed’s inflation.

So it’s obvious that the solution is to ignore the cause, and only treat the symptoms, and then blame the people who have become rightfully expecting of inflation, rather than those who brought about the inflation. It doesn’t matter if inflation will just bring about a further impetus to resist wage decreases. Those with power must focus only on the symptoms, for the symptoms are the most obvious and easy to deal with given the fact that the Fed exists.

Anthony January 31, 2011 at 9:32 pm

A valid point, Blackadder. I would be interested to find the answer to that as well.

Captain_Freedom February 1, 2011 at 9:06 am

“Also, while I don’t want to get off on too much of a tangent, but the attempt to pin high unemployment during the early years of the Great Depression on Hoover’s pleas not to cut wages strikes me as deeply unpersuasive. In any other context Austrians would snicker at the idea that the government could impede normal market processes simply by using moral suasion. Hoover’s unemployment conference was the equivalent of the Ford people wearing WIN buttons, but apparently the man was so persuasive that he managed to keep all employers (not just those at the conference) from cutting wages for years, even to the point that you had 25% unemployment.”

Not only do Austrians not hold that higher real wages was the only cause for unemployment during the Great Depression, but Austrians would also certainly not snicker at the idea that government can influence market actors through means other than legal enforcement.

That Austrians emphasize Hoover’s conference is to not only to show historical revisionists that Hoover was not “laissez-faire”, but also to show that employers across the country did in fact keep wage rates high due to this conference. Henry Ford for example was at that conference, and he made it quite clear that he was in agreement with Hoover. Henry Ford was one of the country’s most revered businessmen. That he was explicit in his agreement to prop up wage rates is not something that a person interested in history would ignore.

Hoover announced that conference:

“[Your agreement is] an advance in the whole conception of the relationship of business to public welfare. You represent the business of the United States, undertaking through your own voluntary action to contribute something very definite to the advancement of stability and progress in our economic life. This is a far cry from the arbitrary and dog-eat-dog attitude of the business world of some thirty or forty years ago.”

Treasury Secretary Mellon then reiterated his boss’ position in 1931:

“In this country, there has been a concerted and determined effort on the part of both government and business not only to prevent any reduction in wages but to keep the maximum number of men employed, and thereby to increase consumption. It must be remembered that the all-important factor is purchasing power, and purchasing power…is dependent to a great extent on the standard of living…that standard of living must be maintained at all costs.”

The fact that wage rates fell by only 3% in 1931 (whereas in 1920 they fell by around 20%), and that prices in 1931 fell by 8.8%, well, it doesn’t take much critical thinking to understand that real wages rose because of a government-business concerted effort to prop up wage rates, and thus contributed to the unemployment problem.

There are many others reasons for why unemployment rose, but the main point is that Austrians do not blame ONLY that Hoover conference. In addition, Austrians do not “snicker” at business-government extra-legal collusion.

Stephan Kinsella January 31, 2011 at 11:28 am

Bob, don’t some of the “freebankers” use the idea of “sticky wages” as one reason (private) banks need to be able to use fractional-reserve banking to inflate the supply of money so as to prevent or ameliorate this alleged “problem”?

Jonathan M. F. Catalán January 31, 2011 at 12:05 pm

Many free bankers support maintaining the supply of money in circulation on account of the time that it takes for prices to adjust to changes in spending patterns; this may be the price of labor, or it can be the price of anything else. The argument against this is not that these prices are not “sticky” (or that it doesn’t take time for prices to change), but that even if banks issued fiduciary media it doesn’t necessarily mean that this new money will be spent in the same way that it would have been spent had the demand for money not risen. In fact, it’s almost guaranteed that spending patterns will still change, given how the new money was introduced (through the loanable funds market).

DD5 January 31, 2011 at 5:51 pm

If “freebankers” argue that prices are “sticky” during an increase in demand for money, as oppose to other more more ‘normal’ circumstances, then I think one of the arguments against them is unfortunately also to refute the nonsensical notion of “sticky” prices.

james b. longacre February 1, 2011 at 12:24 am

during an increase in demand for money…….

is that a unique state of conciousness ??

james b. longacre February 1, 2011 at 4:20 pm

is a freebanker argument a real argument or a something dishonest and contrived?

Nick Bradley January 31, 2011 at 1:20 pm

Their argument is that real wages would fall while the nominal terms of labor contracts would stay the same.

Enjoy Every Sandwich January 31, 2011 at 12:24 pm

Forgive me for my ignorance, but do these economists have a concrete definition of this term they keep throwing around–the famous “market failure”? Because honestly, the way the term is used it sounds to me as if the definition is “an economic outcome I don’t like”. Since I am not a mind reader and don’t know what they like that’s not very helpful to me in determining if a given economic result meets the definition of “market failure”.

Blackadder January 31, 2011 at 1:41 pm

A market failure, in my view, is best understood as a failure to have a complete market. Economics says that markets lead to efficient outcomes if certain conditions are met. To the extent that these conditions aren’t met (e.g. you have imperfect information, incomplete property rights, etc.) you have the potential for a market failure.

Captain_Freedom February 1, 2011 at 9:11 am

“A market failure, in my view, is best understood as a failure to have a complete market.”

I choose to not trade with you even though we could have traded had I agreed.

According to your logic, this is a “market failure”, because my choice results in a conceptually collectivist decline in a “complete market” that is supposedly more important than the individuals actually involved.

Imperfect information is not a market failure. It is a “failure” to be omniscient Gods. An individual cannot possibly know all information in every interpersonal exchange he engages in. A modern division of labor society is a division of knowledge society. “Imperfect information” is IMPLIED in civilization. It is not a failure.

james b. longacre February 1, 2011 at 7:23 pm

does a complete market include failures??

nate-m January 31, 2011 at 2:17 pm

You can replace ‘Market Faliure’ with “Market took a shit” or “Policies that ruin your country’s economies”, depending on the context and maybe get a more accurate picture.

Markets/Economies tend to progress in a rather steady rate. This rate in caused by human’s refining their activities to improve efficiency. The market is created by the transformation of matter from one state to another. This transformation adds value. For example you can’t cook using a rock.. but if you use materials in that rock to build a microwave then it can provide a much higher degree of utility… thus value… thus wealth is increased. People save time, save effort, now you have a much larger amount of your time that can be devoted to enjoying life rather then trying to cook things on rocks.

Taking the rocks-to-microwave concept further a ‘market failure’ would mean some event would occur in society that would cause you to no longer be able to make microwaves without finding a more efficient use of the rock or better replacement for the microwave. That is instead of getting something better (super microwave or better toaster oven) you end up with something worse (a rock).

A more realistic and very common example of a market failure would be the ones caused by price fixing. Lets say it’s the 1970′s or some other mythical time in USA history. High government taxes combined with regulations and uncertainty in world markets caused by other governments (aka OPEC) have combined to cause problems. As a result food that people could previously afford is now less affordable.

To counteract that the government decides to institute price fixing. As a result people keep buying food at fixed price. The stores are no longer able to afford to keep the shelves stocked and have less and less money to give to food processors. The food processors now have less and less money and are unable to afford to purchase stock from the farmers. The farmers now have less and less money to take care of their farms, feed the cattle, and buy seed. As a result fields go fallow, farmers shoot cattle because they can no longer afford them, etc etc.

THAT is a example of a market failure.

I am sure that there is some sort of scientific or mathematical representation of this were you can have nice graphs and all that happy stuff. But this is basically it.

P.E. Dixon January 31, 2011 at 3:36 pm

“To counteract that the government decides to institute price fixing.”

Would this not be a failure of governmental policy rather than of the market?

nate-m January 31, 2011 at 6:04 pm

Well if there is a ‘free market’ then there are other types of markets. My example given would be one of a non-free market. :)

Enjoy Every Sandwich January 31, 2011 at 3:56 pm

My apologies, I didn’t phrase my question clearly enough. What I mean to ask is, how does a Keynesian economist define “market failure”. When a Keynesian says, “Such-and-such is a market failure, ergo the government must intervene” how does he determine that?

nate-m January 31, 2011 at 6:03 pm

Oh sorry.

I suppose that is based on what the media is reporting on at the time.

james b. longacre February 1, 2011 at 12:28 am

does all so-called keynesian theory rely on a govt and govt control of money??

the so-called austrian crap seems to talk about either anarchy or no govt control over money but just an ability to tax the competing currencies.

a keynesian failure i guess (if keynesian is such a thing) woudl be a economic outcome that the govt/regime-of-the-day didnt want.

mikey January 31, 2011 at 1:08 pm

Where I live the hot economy has cooled down. Among union construction workers (where wages are locked in by legally binding contracts) unemployment is around 50%.
Non union firms adjusted wages downwards immediately and did not suffer any noticable loss of qualified workers. The wait to go out to work for these firms is a few days, versus about a year
for the halls.Wages are not sticky on the way down, absent things like minimum wage laws,
labor legislation, and government payments to people for not working.
(I have used a bit of empirical evidence here which some critics think is a no-no for Austrians.)

Bob Roddis January 31, 2011 at 1:18 pm

It seems to me that the whole idea about curing “sticky” wages with money dilution is merely to trick workers into accepting lower real wages while their nominal wages stay the same.

Hayek said that this was the essence of “The General Theory”, which he called an ad hoc theory designed to deal with the political problem of high wages in 1936 Britain:

http://hayekcenter.org/?p=2701

and

http://tinyurl.com/65yf57y

Blackadder January 31, 2011 at 1:36 pm

It seems to me that the whole idea about curing “sticky” wages with money dilution is merely to trick workers into accepting lower real wages while their nominal wages stay the same.

Then you have misunderstood the idea.

When you have deflation + sticky wages, real wages go up. To compensate, employers have to lay off workers and so unemployment goes up. Preventing that doesn’t make real wages go down, it just prevents the situation where real wages and unemployment are shooting up at the same time.

Bob Roddis January 31, 2011 at 1:59 pm

I understand the situation because Hayek explained the situation. The British workers’ wages were, in fact, “too high” due to deflation, but it was politically impossible to get them to agree to lower their wages. Thus, it was essential that the central bank dilute the value of the pound to lower their real wages in a sneaky, underhanded way, but one that was good for “society”. But if there hadn’t been money dilution earlier, there wouldn’t have been problems caused by money implosion later.

This subject reminds me of this:

During this time, I was also in charge of directing pre-fire suppression activities in a nearby town, such as removing vegetation adjacent to structures and thinning out trees to break up potential fuels. Afterwards, I doused the structures with gasoline and decorated the branches with red, white and blue paper lanterns. The whole town burned down.

Then I created a team to liaise with local business owners at a still-standing strip mall that wasn’t doing too well, identifying common goals and working together to meet community objectives: My team set fire to the strip mall and received a 10% cut of the insurance checks. Then we torched a “Ron Paul 2012″ billboard just for kicks. What a summer! Local business owners wanted me to run for mayor, but I felt I was destined for bigger and better things.

After my stint as a firefighter, I had a nice nest egg, so I decided to do some traveling in Europe. I ended up obtaining a job as the Head of Security at the Louvre. There, my mission was to protect the priceless works of art from theft and damage. Because I had unchecked and unparalleled access to the collections, and because it seemed to me that that most of those pretty pictures would garner a pretty penny, I began to network internationally with art lovers during the day and became well versed in art “dealing” at night. I was careful to replace every work of art that I sold with a dead ringer imitation so as not to deprive the public of the pleasure of enjoying these treasures of human civilization.

The French Ministry of Culture did begin to suspect something was up after they noticed all of those armored vehicles pulling up to the loading dock night after night, but when they called me out on it, I reminded them of the dangers inherent in the politicization of art, and the need for the world of art to remain independent of all things political, like questions about force and fraud. The Ministry backed off. When they decided they wanted to go to war with some Middle Eastern country, I fronted them the money out of my lucrative earnings and they have left me alone ever since. In fact, my friends at the Ministry have recently been egging me to lead the E.U. or the U.N. or some other pseudo-governing body, but I felt I was destined for even bigger, even better things.

As for my current professional objectives, I thought about running for President of the United States, but I wouldn’t like that kind of spotlight. I wouldn’t want to be accountable to the American public. I wouldn’t want to hear their whiny, little voices all the time or have to explain what I’m doing. I wouldn’t want to kowtow to anybody. Then it occurred to me: The Fed!

http://www.lewrockwell.com/orig9/finnigan4.1.1.html

Blackadder January 31, 2011 at 2:40 pm

Bob,

If you are talking about the British experience in the 1920s, deflation happened because Churchill picked the wrong peg when the country went back on the gold standard. If he had picked a different peg there would have been no problem. Not sure what is sneaky or underhanded about that.

Bob Roddis January 31, 2011 at 3:22 pm

It’s “sneaky” because the victims won’t agree to a pay cut. So it’s done in a way that they hopefully won’t notice. But then came COLA.

Gil January 31, 2011 at 7:56 pm

Who’s the victims? It would said business owners don’t get to choose their pofits therefore workers can’t choose their wages. Just as there will be times of low profitability for businesses so too will workers be obliged to take a pay cut or lose their jobs.

james b. longacre February 1, 2011 at 12:30 am

do layoffs also occur here more often….would less overall wages meaning ‘not so sticky’ after all because wages now isnt the same as wages wuz??? there are fewer overall wages to measure so they really arent so sticky.

fundamentalist January 31, 2011 at 3:19 pm

Hayek contributes a lot to the explanation of unemployment, too. His Ricardo Effect explains unemployment as the lack of demand for capital goods due to a decrease in the relative wages for consumer goods producers, which causes consumer goods producers to use more labor and less capital (which also taught in graduate micro econ).

And he notes that all jobs today require capital equipment. A great deal of capital equipment, such as auto plants, becomes worthless in the boom and the workers who relied on that equipment for jobs will be jobless until savings and investment produce more capital somewhere else.

So even if wages and prices were perfectly flexible, it wouldn’t ease either of the two problems above. But mainstream econ will never get it until they decide to take capital seriously as a part of the economy.

Bob Roddis January 31, 2011 at 3:24 pm

It seems to me that these “sticky wages” problems are all the cause of fiat money and/or fractional reserve banking and are exactly the types of problems Austrians warn about until they are blue in the face. Further, if you are so stubborn that you won’t lower your nominal wage to get a job, who cares? That’s you’re problem. While you’re at it, why not try holding your breath until you turn purple? Let’s wring our hands to develop a government policy to cure that.

Bob Roddis January 31, 2011 at 3:33 pm

Being senile, I noticed that I think I should have said:

It seems to me that these “sticky wages” problems are all the RESULT of fiat money etc…

Also, the dilutionists seem to be claiming that the Rothbardians think that the post boom recalculation is inherently simple, easy and painless. That’s nonsense. Such a recalculation is always going to be painful, gut-wrenching, unfair and horrendous. It’s just that historically, these recalculations seem to happen fairly quickly if the government does not interfere.

Again, let’s solve the problem by getting rid of fiat money and fractional reserve banking.

james b. longacre February 1, 2011 at 12:32 am

i saw inflation called a disease and ill at these sites. diseases and ills are bad.

is the federal reserve harming you?? are you better off or worse due to the fed or your own shortcomings??

james b. longacre February 1, 2011 at 4:26 pm

it seems to me that these “sticky wages” problems are all the RESULT of fiat money etc…

is the sticky wage a real phenomenon?

would wages likely always more more resistant to change that a regular priced good??

what are the problems of a sticky wage? do layoffs take care of the sticky wage problem??

“happen fairly quickly if the government does not interfere.” when has that happened?

Nick Bradley January 31, 2011 at 4:59 pm

I disagree; As Hayek taught us, even free markets can be inefficient at first if they are not good at transmitting critical price information. Labor markets in general are inefficient for many reasons:

1. Workers don’t have enough information about what their services are really worth
2. Workers generally don’t like to switch companies and move
3. Workers gain non-monetary/non-economic (psychic) compensation from employment in many cases — they have friends at work, they get satisfaction out of their job, etc.

For capital markets, factors 2 and 3 don’t really exist, and factor #1 is becoming less of an issue over time. We can reduce these labor market “stickiness factors” by increasing labor mobility and the sharing of market information:

http://crwl.blogspot.com/2011/01/why-are-wages-sticky.html

DD5 January 31, 2011 at 6:11 pm

1. So the market is inefficient because there is no perfect knowledge. And what is their service “really worth”? As in objective value theory?

2. The market is inefficient because actors make choices according to their own value judgments and not according to Mr. Bradley’s calculated trajectory paths.

3. The market is inefficient because they voluntarily derive part of their income in non-monetary terms.

Nick Bradley January 31, 2011 at 7:30 pm

1. inefficient = less than perfect. I understand that there is no perfect knowledge and reject EMH. My point is that as the ability to spread information in a market increases, it becomes MORE efficient.

2. Obviously, their own value judgments. I can’t make a casual observation? The point I was trying to make is that labor markets are always going to be illiquid because people don’t like to move if they don’t have to — unlike capital.

3. My point is that a worker will gladly stay in a job that pays a wage at below market-clearing prices because of other incentives.

DD5 January 31, 2011 at 9:13 pm

So your brilliant insight is what exactly? That markets are not perfect (whatever “perfect” can even possibly mean in this context)?

DD5 January 31, 2011 at 9:15 pm

3. non-sequitur. All prices are below or above some imaginary clearing price that only exists in your equilibrium models.

james b. longacre February 1, 2011 at 7:21 pm

As Hayek taught us, even free markets can be inefficient at first…….

did hayek teach you that or have you seen it yourself.

Nikolaj January 31, 2011 at 3:30 pm

Stephan,

that’s exactly what the free bankers advocate. Actually, I think that Roger Garrison has an explicit argument to that effect:

“With a less than perfectly flexible price system, general deflationary pressures can push the economy bellow its potential during period in which prices are adjusting to the higher monetary demand. And the fact that some prices and some wages are more flexible than others means that the adjustment period will involve changes in relative prices that reflect no changes in relative scarcities. These are precisely the kinds of problems…avoided by free banking’s responsiveness to increases in money demand”.

Obviously, he believes that the credit inflation during the bust phase had no distortionary effects whatsoever, but on the contrary, has an ability to correct the distortions in relatives prices brought deflation. Credit inflation somehow provides that prices reflect the “real scarcities”.

james b. longacre February 1, 2011 at 12:34 am

Obviously, he believes that the credit inflation during the bust phase had no distortionary effects whatsoever, ……

distortion bad or distortion good??

Nikolaj January 31, 2011 at 3:37 pm

Stephan,

that’s exactly what the free bankers advocate. Actually, I think that Roger Garrison has an explicit argument to that effect:

“With a less than perfectly flexible price system, general deflationary pressures can push the economy bellow its potential during period in which prices are adjusting to the higher monetary demand. And the fact that some prices and some wages are more flexible than others means that the adjustment period will involve changes in relative prices that reflect no changes in relative scarcities. These are precisely the kinds of problems…avoided by free banking’s responsiveness to increases in money demand”.

Obviously, he believes that the credit inflation during the bust phase had no distortionary effects whatsoever, but on the contrary, has an ability to correct the distortions in relatives prices brought about by deflation. Credit inflation somehow provides that prices reflect the “real scarcities”.

Bob Roddis January 31, 2011 at 3:56 pm

Maybe I’m dumb, but I don’t understand this “free banker” stuff. My daughter came home from college with 96 cents in her bank account. Why couldn’t I loan out jumbo $10 million loans at 10% interest using that as reserves? Why can’t I do this but a “free bank” can?

What do the private fractional reserve bank notes say? I understand what demand deposits might say and what time deposits might say, but what legal language do you use for negotiable paper representing a demand deposit that just might not be there?

Jonathan M. F. Catalán January 31, 2011 at 4:58 pm

In the free banking system envisioned by Selgin, et. al., the amount of fiduciary media a bank can extend is not governed by a reserve ratio. It’s guided only by the amount of returning liabilities a bank has to deal with. An increase in demand for that bank’s money will lead to a temporary fall (for as long as that money is held) in returning liabilities (since those notes are no longer being circulated). With a decrease in returning liabilities, the theory suggests that banks can then issue more liabilities (fiduciary media), until the velocity of returning liabilities rises again. In a healthy economy, the changes in outstanding fiduciary media are bound to be very slight, since demand for money doesn’t change much (historically speaking, at least).

Bob Roddis January 31, 2011 at 5:18 pm

What does the negotiable paper say? Who owns what and who owes what to whom?

Again, I can draft the note for the time deposit and I can draft the note for the demand deposit. It’s this hybrid demand deposit that just might not be there (which isn’t a demand deposit) that has me stumped.

Blackadder January 31, 2011 at 5:01 pm

Bob,

There are no reserve requirements for individuals. If you want to loan someone money you don’t need to keep an equivalent amount in a safety deposit box somewhere.

Blackadder January 31, 2011 at 5:04 pm

Btw, if the anti-fractional reserve banking folks are right, shouldn’t there be a correlation between the level of reserve requirements and the number and severity of economic downturns? That is, a country with 90% reserve requirements should get into less trouble than a country with 80% reserves, and so on.

Captain_Freedom February 1, 2011 at 9:13 am

Not if reserve requirements are not even obeyed, as is the case in the US. You therefore cannot use “official” reserve percentages as a variable.

james b. longacre February 1, 2011 at 12:35 am

you can try at least in freebanktopia.

Julien Couvreur January 31, 2011 at 5:01 pm

I was trying to think of a term to illustrate why malinvestment cannot be quickly corrected. I’m thinking of either “sticky capital” or “sticky production structure”. Do you think either helps get the concept across?

The point is that there is a real problem which makes the adjustment difficult. It is a combination of committed capital (bricks that are already mortared in, and are thus “sticky”) and re-discovery of the various prices (the noise created by the credit expansion needs to be filtered out) to enable entrepreneurial calculation.

One question about “sticky wages”: this notion implies some kind of psychological or cultural bias (wages have to rise). What about under the gold standard, when most prices tend to fall as productivity rises? Did we have a historical period of falling wages during normal economic times?

Nick Bradley January 31, 2011 at 5:29 pm

“Sticky Capital”? Those dollar signs with a bunch of zeros you see are claims on real assets that must be transferred. During a correction, firms go bankrupt. The Bankruptcy process is very long, with multiple creditors laying claims on physical assets.

As the bankruptcy process liquidates the malinvestment, the economy will recover. Bankruptcies for financial institutions go much quicker, since there aren’t many physical assets to fight over.

If there weren’t a TARP bailout, many of the large banks that made poor investments would have went bankrupt immediately. The firms that bought their mortgages for 25 cents on the dollar would have had no problem making a 50% write-down on a home. Such a drastic drop in housing prices would have made the market clear pretty quickly, and we’d be back to normal.

james b. longacre February 1, 2011 at 12:37 am

During a correction, firms go bankrupt. ……

can they go bankrupt anytime??

james b. longacre February 1, 2011 at 12:37 am

I was trying to think of a term to illustrate why malinvestment cannot be quickly corrected…….

is there a term for a pro investment cycle under the same currency conditions as the austrians claim occurs?? rather than bubbles are there plateaus that are are continuously reached???

Maurizio February 2, 2011 at 3:07 am

Even if wages do NOT adjust downwards, and employment goes down, this may still be an optimal outcome. Even if Bob does not spell this out explicitely, I think his article provides one argument for that thesis.

james b. longacre February 2, 2011 at 2:15 pm

i dont know how you think market mistakes are optimal. if you were one laid off you woundtnt think gosh, im so glad my liquidation served the market.

i guess that is just the dark side to market opertions. layoffs

sweatervest February 2, 2011 at 2:28 pm

“i guess that is just the dark side to market opertions. layoffs”

As opposed to command economies, where the dark side is slavery.

I’d much rather get laid off and have to find another job than be told be the director of economic affairs where I will work and how much I will get paid for it.

We don’t live in the Garden of Eden. Some times people will lose their jobs. This is in no imaginable way a criticism of markets.

J. Murray February 2, 2011 at 2:30 pm

It’s only defined as a mistake in hindsight. If everyone had 100% projection capabilities, then profits would be 0% all the time as everyone knows exactly what to buy and sell things for.

The harsh reality is we simply cannot protect people and their chosen profession in their chosen area with a chosen organization. Mistakes happen and because mistakes happen it’s imperative we do not allow any centralization or regulation in decision making because then mistakes will happen everywhere at once, instead of in relative isolation.

Jim Rose February 2, 2011 at 3:38 am

The relevant explanation for sticky wages and prices in Alchian (1969) is there are three ways to adjust to unanticipated demand fluctuations:
• output adjustments;
• price adjustments; and
• Inventories and queues (including reservations).

There is no reason for wags and price changes to be used regardless of the relative cost of these other options:
• The cost of output adjustment stems from the fact that marginal costs rise with output.
• The cost of price adjustment arises because uncertain prices and wages induce costly search by buyers and sellers seeking the best offer.
• The third method of adjustment has holding and queuing costs.

There is a tendency for unpredicted price and wage changes to induce costly additional search. Long-term contracts including implicit contracts arise to share risks and curb opportunism over sunken investments in relationship-specific capital. These factors lead to queues, unemployment, spare capacity, layoffs, shortages, inventories and non-price rationing in conjunction with wage stability.

Alchian and Woodward’s 1987 ‘Reflections on a theory of the firm’ says:

“… the notion of a quickly equilibrating market price is baffling save in a very few markets. Imagine an employer and an employee. Will they renegotiate price every hour, or with every perceived change in circumstances? If the employee is a waiter in a restaurant, would the waiter’s wage be renegotiated with every new customer? Would it be renegotiated to zero when no customers are present, and then back to a high level that would extract the entire customer value when a queue appears? … But what is the right interval for renegotiation or change in price? The usual answer ‘as soon as demand or supply changes’ is uninformative.”

Alchian and Woodward then go on to a long discussion of the role of protecting composite quasi-rents from dependent resources as the decider of the timing of wage and price revisions.

Alchian and Woodward explain unemployment to the side effect of the purpose of wage and price rigidity, which is the prevention of hold-ups over dependent assets. They note that unemployment cannot be understood until am adequate theory of the firm explains the type of contracts the members of a firm contract with one another.

Walter Oi has also written on slack capacity as being productive and he included references back to W.H. Hutt.

Oi’s work on retailing and supermarkets spends a lot of time explaining how an empty store is efficient because the owners are waiting for a mass of customers to arrive at unpredictable time. Oi redeveloped the term the economies of massed reserves to describe this. Oi thought that this was a better term than Hutt’s pseudo-idleness.

Oi argued that all resource idleness could, in principle, be eliminated, but to accomplish this, the synchronization of the arrival rates of customers, sales clerks, and just-in-time inventories would be prohibitively expensive.

Benjamin Klein’s theory of rigid wages in American Economic Review in 1984 is one of the few that explored rigid wages as an industrial organisation issue. Klein treated rigid wages as a response to opportunism and hold-up problems over specialised assets and are forms of exclusive dealership or take-or-pay contracts.

The labour market is better understood by forgetting it is the labour market and treating it as a market for long-term contracts for relationship-specific services, firm-specific human capital and mutually dependent assets owned by multiple parties.

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