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Sticky wages arise from long-term contracts, efficiency wage considerations (firms maintain above-market wages to motivate workers), and worker resistance to nominal cuts due to fairness norms. Wage stickiness is stronger than price stickiness.
Use examples: during recessions, firms lay off workers rather than cutting all wages proportionally, reflecting morale and fairness concerns. Compare to prices, which fall more readily.
If markets always cleared instantly, a recession would simply push wages down until employers were willing to hire again — unemployment would be brief and self-correcting. But wages don't behave like tomato prices. Understanding why requires grasping three distinct mechanisms, each rooted in the incentives you've already studied at the firm and household level.
The first source is long-term labor contracts. Firms and workers often negotiate wages months or years in advance, trading wage certainty against the risk that market conditions shift. A worker locked into a two-year contract at $50/hour cannot have that wage cut to $40 just because demand fell — the contract is legally binding. Even when contracts are informal, implicit agreements do similar work: workers accept a "deal" that includes wage stability in exchange for loyalty and predictability. During a recession, these commitments become economic anchors that keep nominal wages above where a spot market would set them.
The second source is efficiency wage theory, and it turns the usual story on its head. Normally we think high wages are a cost firms want to minimize. But a firm paying above-market wages may actually *benefit* — workers are more productive, less likely to shirk (since getting fired is expensive), and less likely to quit (reducing costly turnover). If cutting wages undermines these productivity gains, the wage cut that looks like savings on paper actually costs the firm more in lost output and higher quit rates. So firms choose to hold wages up even when they could legally cut them. This is a rational, profit-maximizing choice, not irrationality.
The third source is fairness norms and worker morale. Experimental evidence and survey studies (famously summarized by Truman Bewley) show that workers experience nominal wage cuts as a breach of trust, even when real wages have already eroded through inflation. A 5% wage cut triggers resentment, sabotage risk, and resignations in ways that a 5% raise-minus-5%-inflation does not, even though the real outcome is identical. Firms understand this psychology and avoid nominal cuts to preserve team cohesion and effort norms. The result is that downward nominal wage rigidity — the tendency for wages to resist falling even when unemployment rises — is much stronger than the symmetric reluctance of prices to fall.
When these mechanisms combine with the natural rate hypothesis you've already studied, the macroeconomic implication is stark: a negative demand shock doesn't quickly lower wages and re-employ workers. Instead, firms respond to lower demand by laying off workers while keeping wages high for those who remain. Unemployment rises and persists until either demand recovers or (over a longer horizon) wage norms gradually erode. This mechanism is central to Keynesian and New Keynesian explanations for why recessions last as long as they do — and why stimulative policy can reduce unemployment without waiting for the market to self-correct through wage adjustment.