What happens if prices become stickier than wages?

- "Traditionally, it is believed that prices of goods and services are relatively flexible and nominal wages relatively sticky. The goods market therefore rapidly returns to equilibrium, while the labour market disequilibrium (unemployment) may persist. In this configuration, a fall in demand for goods (for instance a rise in the savings rate after a wealth loss) drives down prices and drives up the real wage, leading to a fall in output and employment but also a boost in household demand, drives down profits and therefore investment."
- "But in contemporary economies (we look at the situations in the United States and the euro zone) the labour market has become more competitive, whereas inflation is very inert, which must reflect the shortfall in competition in product and service markets. If wages have become more flexible than prices, the reaction of the economy is totally changed. A fall in demand drives down output and employment, but not prices; the nominal wage is curbed, leading to a fall in the real wage that amplifies the decline in household demand, but boosts profits. This is definitely the dynamics seen today, which is unfavourable if the propensity to spend profits is lower than the propensity to spend wages."

Natixis Flash Economics 455 20100914

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