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Krugman: "Sticky Wages I Win, Flexible Wages You Lose"

Krugman: "Sticky Wages I Win, Flexible Wages You Lose"
Profile photo of Robert P. Murphy

The fun thing about Paul Krugman is that you often can use his own charts against him. For a recent example, consider the issue of “sticky wages.” One of the typical complaints against a hardline “the market always clears” position is to say that, for whatever reason, employers are reluctant to actually reduce nominal wage rates. Therefore–the interventionist argument goes–the normal mechanisms of market recovery to a drop in demand don’t work if the new market-clearing wage rate is lower than before. This leads to involuntary unemployment because the market is simply stuck. Therefore, we need the State to come in and run budget deficits to boost Aggregate Demand.

In a recent post, Krugman thought he laid down a trump card making this point, with the following commentary and chart:

But there’s a lot of denial out there. Recently David Glasner deconstructed a WSJ op-ed calling for a return to the gold standard, which was as out of touch as you might expect. But what got me was the approving citation of Robert Mundell from 1971 (!) declaring that the Keynesian model was irrelevant to modern economies because it assumed pessimistic expectations and rigid wages. Right: no pessimism out there these days. And no sticky wages; oh, wait:

Spain Nominal Wage Adjustment

 

I mean, seriously, at this point even long-time skeptics about short-run wage and price stickiness are coming around in the face of overwhelming evidence.

Now look more closely at that chart Krugman posted. In case it’s not obvious, Krugman’s point is that the distribution of wage changes in 2011/12 shows a big spike at 0%. In contrast, the changes in 07/08 looked more like a bell curve. Therefore, the obvious implication is that the wage changes that “should” have been negative got piled up at the 0% mark, because those employers were reluctant (for whatever reason) to actually reduce nominal wages; instead they merely kept wages constant.

Now that we understand the claim Krugman is making, we have to ask, Is this really decisive when it comes to the issue of allowing labor markets to clear on their own? If we assume (as Krugman himself seems to be doing) that the red wage distribution “should” have been like the blue one, only shifted to the left, then the presence of the 0% boundary looks as if it bulked up the distribution of changes by about 13 percentage points or so, higher than what it “should” have been at the 0% mark. Just eyeballing the chart, from 2011-12 in Spain more than half of the labor force saw an increase in their nominal wages, and there were still about 20 percent or so who saw a reduction in nominal wages. (Since the people who saw no change represented about 28 percent, that means the other two groups have to add up to 72 percent.)

Indeed, the chart shows that around 5 percent or so of the labor force saw a one-year drop in wages between 5 and 10 percent. That’s a pretty big drop, for 5 percent of the labor force, when we’re talking about “sticky wages.”

All in all, Krugman’s chart about Spain suggests to me that there’s nothing inherent in market economies per se that prevents nominal wages from falling. In practice, at best the case of Spain shows that 13 percent (or so) of the labor market had its wage adjustments significantly hampered by this psychological barrier.

That means we can now go back to Krugman and spit this in his face, right? Ha ha, innocent reader, if you thought that, it shows you don’t know Krugman. For example, when Chicago’s Casey Mulligan wrote a critique of the (New) Keynesian position, in which Mulligan assumed sticky wages and prices were central to their case, Krugman responded in a post entitled “Why Casey Can’t Read”:

If he had read anything — anything at all — that Keynesians have written about policy at the zero lower bound, he would have learned that there is no reason to expect falling wages and prices to raise employment — in fact, quite the contrary in the face of a debt overhang.

If Mulligan wants to argue that point, fine — but he presents as “the New Keynesian position” something that is just what he imagines, on casual reflection (or, again, maybe after talking to some guy in a bar) to be the New Keynesian position.

OK, so from now on I’ll assert that the Chicago position on unemployment is that we can cure it by sacrificing goats.

This would be a great analogy, if Casey Mulligan had posted graphs of goat sacrifices in Australia in a discussion of why they didn’t get hurt so bad in the crash.

In summary:

(1) Krugman can’t believe the idiots who try to reject the Keynesian policy prescriptions by denying that there are sticky wages and prices. Just open your eyes, guys! Wages are clearly sticky and so the classical solutions fail; that’s why we need bigger government deficits.

(2) Krugman can’t believe the idiots who try to reject the Keynesian policy prescriptions by looking at the empirical relevance of sticky wages and prices. Try reading what the Keynesians are actually writing, you liars! If wages fell it would exacerbate nominal debt burdens; that’s why we need bigger government deficits.

(3) The empirical evidence for the need for bigger government deficits is overwhelming at this point. The Keynesian model came through this crisis with flying colors. Anyone who denies that is a knave or fool.

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Profile photo of Robert P. Murphy

Robert P. Murphy is the Senior Economist at the Institute for Energy Research, and a Senior Fellow with the Fraser Institute. He holds a PhD in economics from New York University. Murphy is the author of Choice: Cooperation, Enterprise, and Human Action (Independent Institute, 2015) as well as numerous other books and hundreds of articles.

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