Wages determination in EU

Real or nominal wage flexibility is understood as the speed with which real or nominal wages adjust to real or nominal shocks. The nature of the shock is not the main reason for the real or nominal wage rigidities. Then due to rigidities interaction, nominal and real shocks determine distribution how prices and quantities change as a response to unexpected changes in price or technological shocks. The changes in economy sometimes enforce also the change in wage rates and the measure of respond of the wage rate to new conditions on the market is called flexibility. There are three basic different concepts of nominal and real wage flexibility.

• The response of nominal wages to changes in price level or inflation.
The delay in the reaction of nominal wages to price changes determines the degree of nominal wage inertia. The degree of nominal wage inertia is high in the case when real or nominal shocks cause only minor change in inflation that is further transferred on nominal wages. This theory has attracted attention of many economists as nominal wages are believed to be rigid concerning the downwards direction.

• The response of real wages to labour market conditions due to the presence of labour market frictions.
Real wage flexibility is low when it takes time for a dis-equilibrium in the labour market to be eliminated. Similarly, high level of real rigidity entails a situation where real wages or mark-up of price over marginal costs respond little to demand pressures.

• The response of wages to changes in composition of labour demand or labour supply.
This flexibility is narrowly associated with geographical, sectoral and skill mismatch. In case that this shock appears, relative prices and wages need to be adjusted in order to enable the labour demand and labour supply to be balanced.
Both neo-classical and new-Keynesian economics share the opinion that unemployment is a result of wage rigidity (not flexible wages). The neo-classical economists also affirm that nominal and real wages are positively correlated, which means that if the money wage is cut then as a result the real wage is also cut. Consequently, rigidity of nominal wages together with some bargaining arrangements is the reason for involuntary unemployment. Whereas according to Keynes economists, the wage, achieved by bargaining process between companies and workers, does not have impact on real wages. This means that for the involuntary unemployment is responsible failure coordination at the system level rather than coordination failures at the labour market level. Keynes believes that coordination is the central issue in economic activity. According to this theory, involuntary unemployment is a result of lack of coordination which appears along the way but we cannot prevent it simply just by allowing the price and flexible wages.
Keynesian theory further states that real as well as nominal rigidities are not the obstacle on a way to full employment but just the other way around they might be useful to prevent an aggravation of unemployment. Secondly market imperfections are also not understood as obstacles to reach equilibrium but rather than that they are one of the factors of the stability of the system.