Nominal wages are fixed for the employed. NGDP falls 5%, and 5% of workers are laid off. Now the unemployed workers lower their wage demands by 20%. Why not by even more? Because of minimum wage laws, unemployment insurance, fear of loss of prestige, etc.
Suppose companies are not worried about workers making invidious comparisons (a big if, but I’ll grant this point to my opponents.) In the best case scenario firms lay off 4% percent of their workers and hire back the 5% who are unemployed at the same total wage bill. The excess unemployment is now 4% instead of 5%. The total unemployment rate falls from 10% to 9% (assuming 5% is the natural rate.) No big deal, we are still deep in recession. Thus wage flexibility among the unemployed doesn’t really help very much. If all employed workers accepted a 5% pay cut (or if the government ordered such a cut) and the Fed kept targeting inflation, we’d experience rapid economic growth.
Most of all, I praise Scott for being the only respondent, of many, to actually try and explain why nominal wages are sticky.
As the argument is presented, I would respond: “There is talk of fixed NGDP and talk of a fixed total wage bill. Both conditions are assuming away the possibility of an easy solution. An unemployed worker shows up, he and the employer cut a deal, a job is created, monetary velocity goes up, NGDP goes up, and the Pareto improvement occurs. To use a different terminology, velocity should be elastic with respect to available gains from trade and thus so is NGDP. More concretely, referring to the current day, employers are sitting on plenty of cash. There is nothing in the NGDP identities to prevent further hiring from that stash.”
You can read Scott’s not-easy to-summarize counter-response to a comparable comment of mine here. I do not interpret it as defending the relevance of nominal stickiness over the longer run or even as hoeing to the above passage. For instance Scott writes “the actual change in NGDP is a sufficient statistic for understanding the net effect of wage flexibility on NGDP, PLUS monetary policy on NGDP.” I believe Scott could have more accurately written”: “the actual change in NGDP is a sufficient statistic for understanding the net effect of labor market and other coordination breakdowns on NGDP, PLUS monetary policy on NGDP,” removing wage stickiness from the sentence altogether. We’re back to viewing wage stickiness as one component of GDP problems, without knowing how important wage stickiness for the unemployed is, which is precisely where we started.