[W]age stickiness is a much bigger problem when inflation is low, not
high. In 1982 all employers had to do to restore labor market
equilibrium was grant smaller pay increases. In contrast, consider the
following example from George Selgin:
Here at UGA we haven't had any raises for five years running. I know professors elsewhere with similar experiences.
...So each year the UGA administration sat
down and discussed all the possible pay increases they could grant. How
about 2%? How about 0.5%? How about negative 1%? And so on and so on. Then it just so happens they decided on 0%? What a coincidence!
The odds must be 10 to 1 against that particular number. And then the
next year it was zero again! And the next year. Now you are talking a
1000 to 1 shot. And the next. And the next. Amazing coincidence? Or
money illusion? I think you know where I stand, just from the title of
this blog. I don't know why people have money illusion, and it's
certainly a bizarre thing to put into a model. But it's there.
Money illusion is one of my
few concessions to the behavioral economists. I wish it weren't
there--it makes our models much uglier and it causes enormous human
suffering. But wishing it weren't there doesn't make it go away. "The
world is as it is." Between mid-2008 and mid-2009, NGDP fell about 9%
below trend, while wages kept chugging along at roughly trend. That's a
really big problem. Although unemployment has since fallen from 10% to
8.2%, wages still haven't entirely caught up to that massive demand
There's another problem with using common sense. The real world is
very complex, and no one model can explain everything.
40% increase in the minimum wage right before the recession slowed the
downward adjustment in wages, especially for the lower classes where
unemployment is concentrated. People typically ridicule the minimum
wage hypothesis by saying "Come on, that can't explain all the
unemployment." True, but no one claims it can. Ditto for the extended
UI benefits. The natural rate of unemployment is estimated to be 5.6%,
the actual rate is 2.6% higher. That extra 2.6% is partly extended UI
benefits, partly the big minimum wage increase, and partly sectoral
reallocation of labor. But I believe it is mostly wage stickiness, and
the stock market also seems to think more NGDP would help a lot right
The W/NGDP ratio shot up in 2009, and unemployment soared. Since
then the ratio has come part way back to trend, and the unemployment
rate has come part way back to trend. We have excellent data showing
George Selgin's example is common, wage increases bunch around zero
percent. Until we get a more plausible theory of unemployment, I'm
sticking with stickiness.
I can hardly imagine a sharper contrast between Sumner's official message ("the pitfalls of common sense") and his actual common sense case for the power of nominal wage rigidity. If only he'd titled his post "why nominal rigidity is intuitive" and linked to this!