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Tuesday, 9 August 2011

Sticky salaries and wages

Sticky salaries and wages

The constant real value non–monetary items salaries and wages are generally sticky downwards: it is not easy for firms to reduce them in nominal value. It is, of course, very, very easy to reduce their real values during inflation: just keep them the same or increase them at a rate lower than the inflation rate. People are apparently agreeble to accept the latter option which means a reduction in real value. People are very unhappy to accept a reduction in nominal value of salaries and wages.

It may happen that it could be some time before the concept of enhanced economic stability during deflation via financial capital maintenance in units of constant purchasing power (CIPPA) is generally accepted. Salaries and wages would then be automatically decreased in nominal value by means of measurement in units of constant purchasing power while their real values would stay the same during deflation. This would improve economic stability substantially and help central banks in their task of getting the economy into a low inflationary mode again. It would also reduce the level of the monetary effect of a lower general price level during deflation.

Salaries and wages are already being decreased in nominal value in the labour market during deflation, but, not yet automatically as a normal accounting practice by measuring them in units of constant purchasing power in terms of the negative change in the CPI.

A possible practical way of overcoming the opposition people have in accepting a decrease in salaries and wages during months of negative monthly inflation while the annual inflation rate is still positive (during inflation and disinflation) would be the following:

Employment contracts could state that salaries and wages would be updated (there is no stable measuring unit assumption under IFRS-authorized financial capital maintenance in units of constant purchasing power - CIPPA) in terms of the Daily Index while the DI value is increasing. When it decreases as a result of a period of negative monthly inflation while the annual inflation rate is still positive, salaries and wages would be kept fixed in nominal value during that period in order to give employees certainty as to the amount of money they will receive at month end. They would, of course, be receiving more in real value during the period their salaries and wages are fixed with a decreasing DI. As soon as the Daily Index turns positive again salaries and wages will be updated again in terms of the increasing DI, but, only after allowing a recoupment of the period of the decrease in the DI while annual inflation was still positive. Thus, their salaries and wages would be kept fixed for a little longer while the DI is already increasing. They would, of course, be receiving less in real value during the period their salaries and wages are fixed with an increasing DI. Months of negative monthly inflation during a year of positive annual inflation are normally limited to one or two consecutive months. The net effect to salaries would be the same as always updating them in terms of the DI whether it was increasing or decreasing during continuous annual inflation and disinflation. Neither employers nor employees would be negatively affected in the above case.

During deflation a different approach is required because keeping salaries fixed in nominal value during deflation means their real values are increasing daily and may after some time severely affect entities´ ability to maintain stability in their operations during deflation which may result in layoffs affecting employees in the worst way. On the other hand, employees need certainty about how much money they will receive during the current year in their contracts also during deflation.

Employment contracts could state that during deflation salaries and wages would be kept fixed during the contract year in which the economy first enters into deflation. Contracts could then be agreed to be renegotiated at the end of that contract year and yearly thereafter while the economy remains in deflation with a view to decreasing the nominal values of salaries and wages (not their real values) in a predictable manner in line with deflation. Their real values would remain the same or increases in real terms could be negotiated. It could then also be negotiated to increase salaries and wages in real terms by keeping them fixed during deflation depending on each entities´ specific circumstances.

Nicolaas Smith

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