Reply To: During depressions, are wage cuts…


In analyzing any situation of profit and loss in production, one must look at all costs of production and not just wages. If output prices are falling, then costs of production overall must fall close to proportionately to the fall in output prices to maintain profitability. Costs fall close to proportionately and not exactly proportionately because the interest rate, which is the rate of return or price spread between output prices and input prices, changes over the phases of the cycle. But setting that issue aside, falling output prices will affect the movement of prices of inputs according to the specificity of the inputs. Since labor is generally less specific than capital goods, wages will fall less relative to the fall in output prices and prices of capital goods will fall more relative to the fall in output prices. The symmetric movement occurs during the boom. Prices of capital goods rise relative to wages as prices of output are pushed up by monetary inflation and credit expansion.

Real wages fall over the cycle because capital goods have been malinvested and labor misallocated. Production is less efficient than it would have been had capital and labor not been squandered. Even if nominal wages rise relative to output prices, real wages will be lower because fewer goods have been produced than would have been without the malinvested capital.

It would be very unusual for money to have the same purchasing power at the end of a cycle as it had at the beginning. During the boom there is inflation of the money stock and typically, but not necessarily, a reduction in the demand to hold money and during the bust there can be either deflation or inflation of the money stock and typically, but not necessarily, an increase in the demand to hold money. It’s rare for these various forces to render the same purchasing power of money over time.