Another friction is the stickiness of nominal wages. People seem very unwilling to accept a nominal pay cut, taking this as an attack on their status.
There’s actually a major reason for the stickiness of nominal wages you’ve failed to account for: debt overhang. Any and all debts are calculated in nominal currency, not real currency, so if the labor market deflates (across-the-board salary drops), the debts of everyone who works for a living grow correspondingly more difficult to pay.
This explanation can be generalized: the higher the average (mean or median) level of debt among any given population, the more difficulty markets among that population will have in clearing, because market adjustments don’t change the price-levels on time (hence debt: borrowing is buying time) that has already been bought and sold, forcing everyone to try and obtain the old prices (corresponding to prices when they took their loans) whenever they can.
This is why liberal bankruptcy statutes are one of the most important parts of a functioning market economy: future default risk is supposed to be a risk born by all prospective future lenders, and factored into the interest rate, rather than allowing newly-unpayable debts to drag down price movements throughout the entire economy.
(It’s also why so many instances of bank bailouts lately have created “zombie” economies in which growth remains perpetually low: the misvalued debts were never cleared, but deflationary pressures have set in, so the real economies are being drained of larger amounts of real productivity than the debts originally corresponded to.)
Thus there seems to be little explanatory power in classical explanations that assume that people won’t work because the salary is too low.
Except, of course, when the effective salary, after cost-of-living, relocation costs, training/educational-debt repayments, etc, is negative, in which case it is trivially irrational to take such a job.
(This actually explains more of the “skills gaps” than employers usually want to admit, since that would keep them from purchasing gold for the price of bronze.)
I find this comment very interesting, but I’m generally confused by economics and have a few points of confusion here.
It’s also why so many instances of bank bailouts lately have created “zombie” economies in which growth remains perpetually low: the misvalued debts were never cleared, but deflationary pressures have set in, so the real economies are being drained of larger amounts of real productivity than the debts originally corresponded to.
To check my understanding, is the “underwater mortgage” pattern a concrete example of this?
This explanation can be generalized: the higher the average (mean or median) level of debt among any given population, the more difficulty markets among that population will have in clearing, because market adjustments don’t change the price-levels on time (hence debt: borrowing is buying time) that has already been bought and sold, forcing everyone to try and obtain the old prices (corresponding to prices when they took their loans) whenever they can.
I understand that deflation is bad for debtors, but I’m confused about the concrete ways in which this means the rational behavior of debtors (in contrast to psychological explanations like morale) could be the cause of downward nominal wage rigidity. Is the idea that bankruptcy is an abrupt flat line on the utility-money curve, and so an employee can credibly pre-commit to quitting in response to a nominal pay cut (of certain magnitude), because the pay cut would lead to the same outcome (bankruptcy) as getting fired? And then “no nominal wage cut” emerges as a sort of Schelling point (because the exact degree of nominal wage cut that would lead to bankruptcy is unknown to the employer)?
This explanation can be generalized: the higher the average (mean or median) level of debt among any given population, the more difficulty markets among that population will have in clearing, because market adjustments don’t change the price-levels on time (hence debt: borrowing is buying time) that has already been bought and sold, forcing everyone to try and obtain the old prices (corresponding to prices when they took their loans) whenever they can.
Does this also imply that government debt is less harmful to the economy than private debt, all else being equal?
While I have not rigorously researched that issue, I would call it a plausible view: the state is a single market actor, so outside markets driven entirely by state demand (which, admittedly, are myriad), the state’s problems don’t affect general price-levels.
There’s actually a major reason for the stickiness of nominal wages you’ve failed to account for: debt overhang. Any and all debts are calculated in nominal currency, not real currency, so if the labor market deflates (across-the-board salary drops), the debts of everyone who works for a living grow correspondingly more difficult to pay.
This explanation can be generalized: the higher the average (mean or median) level of debt among any given population, the more difficulty markets among that population will have in clearing, because market adjustments don’t change the price-levels on time (hence debt: borrowing is buying time) that has already been bought and sold, forcing everyone to try and obtain the old prices (corresponding to prices when they took their loans) whenever they can.
This is why liberal bankruptcy statutes are one of the most important parts of a functioning market economy: future default risk is supposed to be a risk born by all prospective future lenders, and factored into the interest rate, rather than allowing newly-unpayable debts to drag down price movements throughout the entire economy.
(It’s also why so many instances of bank bailouts lately have created “zombie” economies in which growth remains perpetually low: the misvalued debts were never cleared, but deflationary pressures have set in, so the real economies are being drained of larger amounts of real productivity than the debts originally corresponded to.)
Except, of course, when the effective salary, after cost-of-living, relocation costs, training/educational-debt repayments, etc, is negative, in which case it is trivially irrational to take such a job.
(This actually explains more of the “skills gaps” than employers usually want to admit, since that would keep them from purchasing gold for the price of bronze.)
I find this comment very interesting, but I’m generally confused by economics and have a few points of confusion here.
To check my understanding, is the “underwater mortgage” pattern a concrete example of this?
I understand that deflation is bad for debtors, but I’m confused about the concrete ways in which this means the rational behavior of debtors (in contrast to psychological explanations like morale) could be the cause of downward nominal wage rigidity. Is the idea that bankruptcy is an abrupt flat line on the utility-money curve, and so an employee can credibly pre-commit to quitting in response to a nominal pay cut (of certain magnitude), because the pay cut would lead to the same outcome (bankruptcy) as getting fired? And then “no nominal wage cut” emerges as a sort of Schelling point (because the exact degree of nominal wage cut that would lead to bankruptcy is unknown to the employer)?
Does this also imply that government debt is less harmful to the economy than private debt, all else being equal?
While I have not rigorously researched that issue, I would call it a plausible view: the state is a single market actor, so outside markets driven entirely by state demand (which, admittedly, are myriad), the state’s problems don’t affect general price-levels.