There are good arguments that wages are sticky for (many of) the employed. Observed wage changes cluster in funny ways, indicating an unwillingness of the boss to change the nominal wage at all, and employers testify to morale problems from wage cuts (see Alan Blinder’s work). In terms of the financial crisis, Keynesian theory explains the initial lay-offs fairly well, but it — at least the sticky nominal wage version — has a tougher time explaining unemployment persistence at such a high level.
Why don’t the unemployed lower their wages to find a job? The more tragic you think unemployment is, the greater the puzzle here, and yet the people who stress the tragedy are often least likely to admit the positive puzzle (and vice versa).
There’s pretty clear evidence that, during the crisis, when the elderly wanted to work more, the elderly were able to work more.
I hear various arguments in response:
1. Falling wages can lead to a downward deflationary spiral, but a) these wage cuts would be for only a few percent of the workforce, b) let’s not confuse the wage rate with the total wage bill, and c) our Fed, however weak, is committed to stopping a downward deflationary spiral.
2. Maybe firms don’t have enough money to take on more workers, especially since the wages of the employed are fairly sticky. Yet businesses are sitting on record-high levels of cash. So while #2 may make sense in theory, it takes a lot more work to apply it to 2011. I don’t see people even trying.
3. In a few unionized sectors, hiring lower-wage add-on workers may antagonize the incumbent workers. Yet a) these sectors are not creating many jobs anyway, and b) in most modern sectors the real morale problem comes when you hire the newbies at higher wages, not lower wages.
4. Another claim is that it is hard for workers to signal that they are willing to work for twenty percent less, or whatever it takes. How about applying for a job at a Washington non-profit? Every time you do so you are signaling an ability to work for considerably less than what you are worth elsewhere. Yet this labor market seems to hire as many people as its revenue stream can support and employers do not throw out all applications. More generally, in down times the unemployed worker doesn’t need to signal much of anything. The worker applies for a job. The employer knows there are a number of workers competing for the job. The employer makes a low-ball wage offer. The worker accepts the offer. End of story.
5. Often I get arguments which either refer back to nominal wage stickiness for the employed, or it is observed that lots of people are out of work so the nominal wage story must be true somehow. Those responses are signs of a weak paradigm. Another set of responses point to and then attack some excessively strong version of the nominal flexibility view, such as mocking the view that the Great Depression was a big voluntary holiday. Another sign of a weak paradigm, don’t fall for it.
One simple view is that Keynesian economics holds true in the short run — it explains a lot of layoffs — but it doesn’t explain longer-run unemployment, precisely because wages are sticky only for a while. That’s what most neo-Keynesian models imply and for the most part those are good (but not perfect) models. What we’re seeing is a previously rejected form of Keynesianism, applied across increasingly long and increasingly implausible time frames — suddenly pretending to be the mainstream view. It’s not and has not been for a long time.
In other words, Keynesianism is morphing into a theory of the long run.
Often when this topic comes up I feel I am playing a game of whack-a-mole. Most of all, I am struck by how little attention people pay to their own sticky nominal wage hypotheses. If that were the problem, and if unemployment were today’s biggest issue (a totally plausible claim), you might expect people to blog the microfoundations of nominal wage stickiness very, very often. You might expect ethnography. Micro-level data. Lots of juicy anecdotes and journalistic features, not just on the unemployed but on the stickiness itself. Perhaps some micro-level advice. Dozens, no hundreds of blog posts on the all-important microfoundations of the #1 social problem of our time.
But no, there’s not much of those to be seen. At some level it is understood, if only implicitly, that the sticky nominal wage theory is an embarrassment — when it comes to the unemployed across the longer run (but not the employed). It doesn’t get too close a look.
What else? Few people want to come out and utter the possibility: “They’re just too stupid and too stubborn to lower their wage demands.” Mood affiliation reigns, and the prevailing mood is to express sympathy with the unemployed. In fact that sentence is not my view, but it actually makes somewhat more sense than most of what is listed above. A lot of people don’t like hypotheses which suggest the unemployed are not victims of the system, so it doesn’t get much of a hearing.
I think, by the way, that excess capacity theories are one of the most plausible attempts to explain continuing unemployment (you’ve already heart about PSST and ZMP, among others). I’ll blog excess capacity more soon, but in the meantime note the hypothesis doesn’t rely on nominal wage stickiness. The firm doesn’t want to produce any more output, so the worker’s wage demands don’t matter so much. This will have real import for the analysis of monetary and fiscal policy, so the microfoundations really matter here.
In the meantime, beware of claims about sticky nominal wages among the unemployed.
Addendum: Arnold Kling comments. And Brad DeLong responds but a) he cannot bring himself to tell us what makes wages sticky for the unemployed, and b) he simply misrepresents my point of view, plus he ignores #1. Scott Sumner responds, but no need to fire the old workers to hire more and don’t reify NGDP! Here is Matt Yglesias, the question is why the labor market adjustment isn’t quicker, unless you are assuming excess capacity. As time passes, the gap should narrow, even for a given level of spending. Kevin Drum seems to embrace excess capacity explanations. Here is Karl Smith, and Ryan Avent, and Robert from Angry Bear.