Saturday, March 05, 2011

The Spectre Of Price Flexibility Clearing Markets

David Leonhardt notes that while employment has improved in the United States in recent months, real wages have begun to fall.

What he fails to note is that there is partly a causal connection between the two: job seekers are finally accepting lower pay, something which makes it profitable for more employers to hire.

It should be noted though that to the extent the reduction in real pay is due to a worsening terms of trade because of for example higher oil prices, then it will not help boost employment. As long as we have a situation of high unemployment however, real wage reductions that don't reflect a weakening terms of trade will boost employment.

By contrast, if the problem had been labor shortages, then higher real wages would boost employment.