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Price and Wage Stickiness -- Myth or Reality?
by Sophia Barkat
Abstract: In the last paper I showed that Central Banks create illusion of recession by reducing money supply thereby creating inflation. This gives them an excuse to reduce interest rates to levels required to borrow money from the public in order to pay for huge budget expenditures -- Defense Spending and Wars, National Debt reduction etc.
In this paper, I show that Central Banks, to shift blame, point fingers at the business community, by saying that Price and Wages stickiness creates Recession. I also attempt to show that neither Prices nor Wages are sticky.
The Paper:
Let's refer to Figure 1-8, page 17 of Macroeconomics, Third Edition, by Hall and Taylor.
The graph suggests that while during a recession Aggregate Demand falls, Aggregate Supply does not. This keeps prices fixed. But is this graph realistic?
In reality, as we saw between 2000 and 2003, the declaration of a recession by the Federal Reserves Bank made businesses reduce inventory growth and capital expenditure growth, forced retail businesses to reduce prices, and caused many businesses to lay-off people.
This is completely at odds with what Hall and Taylor, two economists and authors of the book, suggest.
In fact, businesses are so responsive to good and bad announcements by the Federal Reserves and other Central Banks that the regulators have always been successful at using such announcements about recessions and inflation to reduce interest rates when they need to borrow more money.
So question is are prices and wages sticky or are they just a myth created by Economists who think Governments should be able to borrow money from the public even at the expense of business growth?
Let's see why it's in the best interest of businesses to reduce prices, reduce new capital expenditures and reduce employment or cut wages at the onset of a recession:
Maintain Revenues
Businesses that cut prices can remain competitive. With more and more corporations being able to command large market shares via television and media advertising, price competition is steep in many industries. If you don't cut prices when your competitor is, chances are you will lose customers.
Cheaper Debt
During recessions, businesses expect interest rates to be slashed by Central Banks. This makes them wait before they issue debt -- and thus, do not show positive capital spending growth. They can refinance old debt too at lower interest rates.
Cut Costs
Companies reduce variable expenses like employment, storage, transportation, and inventory, when they expect everyone else to. Since an announcement of a recession makes people think recessions are real, they cut down on costs. Some do this because they expect others to, thereby expecting a reduction in aggregate demand.
So, it's at the advantage of businesses to downsize and cut prices to adapt to recessions. If businesses expect a slow recovery -- or the Government to issue a lot of debt to fix a poorly managed National Budget -- they will cut down on production quite aa bit.
The fact that we see this in reality makes us think that businesses are indeed flexible and responsive to changes in Central Bank announcements about the economy.
In fact, the financial industry -- banks, commercial and investment advisors, investors -- so considers businesses to be responsive to changes in economic expectations that they perform regular studies to see how much prices and wages will change.
The Central Banks make regular announcements about business -- inventory, capital growth, and employment -- because these figures are not rigid but show responsive changes to Central Bank policies.
See Yahoo! Finance for a Calendar of Economics News:
http://finance.yahoo.com/ -- under "Stock Research" and "Financial Caalendars". It shows various macroeconomic -- business and consumer -- variables that both banks and the Federal Reserves collect information on and report on a monthly basis. So, if you see any indicator that a variable is VOLATILE, just remember that this is about numbers that change every month.
Under Retail Sales, it says:
"Retail sales are often viewed ex-autos, as auto sales can move sharply from month-to-month. It is also important to keep an eye on the gas and food components, where changes in sales are often a result of price changes rather than shifting consumer demand.
Retail sales can be quite volatile and the advance reports are subject to rather large revisions. Retail sales do not include spending on services, which makes up over half of total consumption."
Under Consumer Credit, it says:
"This monthly measure of consumer debt is volatile and subject to massive revisions. It is also released well after every other consumer-spending indicator, including weekly chain store sales, auto sales, consumer confidence, retail sales, and personal consumption. For these reasons, the market almost never reacts to the consumer credit report. "
Under Wholesale Inventories, it says:
"Wholesale inventories sometimes swing enough to change the aggregate inventory profile (aggregate inventory is the sum of inventory at the manufacturing, wholesale, and retail levels), which may affect the GDP outlook."
Under International Trade, it says:
"The volatility in the monthly trade balance can play an important role in GDP forecasts. Net exports are a relatively volatile component of GDP, and the trade report provides the only early clues to the net export performance each quarter."
Under Core PPI, or Core Producers Price Index, it says:
"Food and energy prices tend to be quite volatile and obscure trends in the underlying inflation rate."
Nowhere is it suggested businesses are rigid and that such statistics are rigid. They react to consumer demand as well as macroeconomics news.
Hence, the claim that prices and wages are rigid makes no sense.
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