What are sticky wages and what cause them to exist in an economy?

When demand for a good drops, its price typically falls too. That’s how markets adjust to ensure that the quantity of willing suppliers equals the quantity of willing buyers. In theory, things are no different when the good in question is labor, the price of which is wages. So it is quite natural to think that wages should fall in a recession, when demand falls for the goods and services that workers produce. Assuming that the supply of labor does not change, reduced demand for labor should translate into lower wages, until everyone willing to work at the going wage has found employment. Of course, what we tend to observe in a recession instead is unemployment, sometimes on a mass scale, with little movement downward in wages.

But economists have long observed that wages are especially unlikely ever to fall, even in very severe recessions, a phenomenon called “downward wage rigidity.” The reasons for downward wage rigidity are unclear. A number of hypothesis do exist, including one from this author.