Can persistent wage stickiness be the problem?

Stephen Williamson writes:

What about wage stickiness? That’s certainly important in the Keynesian narrative, though New Keynesians tend to think more about sticky prices. Suppose, for the sake of argument that a particular worker’s wage had been stuck at its pre-financial crisis nominal level until now. How much would that worker’s wage have declined in real terms by mid-2013? The answer depends on when the worker’s wage became stuck. If it was in January 2007, the decline would be 12% (using pce inflation); if in December 2007, 9%; and if when Lehman went down, 6%. That’s large in any case, and that’s with zero adjustment over 5 or 6 years. You think wage stickiness matters over that length of time, or that wage stickiness somehow explains the drop in employment we saw in the construction sector? I don’t think so.

Don’t forget that nominal gdp is now well above its pre-crash peak (some sticky wage theorists are morphing into “the stickiness is that almost everyone has to get a two percent raise each year,” a very different proposition than downward stickiness at the zero point and one with much less evidence behind it).

There are several other interesting observations in the piece.  I don’t completely agree with this set of points (for one thing I don’t view TFP and investment as so readily separable), but they are nonetheless worth a ponder:

Probably the most important feature of the data in the two charts is the difference in the behavior of investment. In 1981-82, investment declines by about 12% from the first observation, then rebounds significantly, to the extent that it grew more than consumption and output by mid-1983. In the last recession, investment declined by more than 30% from the beginning of 2007 to mid-2009, and in second quarter 2013 was still about 5% lower than in first quarter 2007. Thus, if there is something we should be focusing on, it’s not multipliers and consumption, but why investment is so low. That low level of investment, over a five year period, has now had a significant cumulative effect on the capital stock. Thus, we’ve got OK growth in TFP, but growth in factor inputs is low. That’s the key story, from a growth accounting point of view.

You should not, by the way, think I have changed my mind on monetary policy.  The “nominalist” approach was absolutely correct for 2008-2009, it is simply becoming less correct as time passes, which is exactly what standard economic theory suggests.


So, if real wages have gone down by 12%, 9%, or 6%, or just 3% or whatever it is since 2000, are wages really sticky???

Why do economists argue that nominal wages are too sticky and need to fall when real wages have been falling for the median worker for decades, and cratering for the lower quartile over the past three decades as they have seen their nominal wages fall even as the real value of real wages has fallen?

And given the rise in debt to fund consumption of non-durable goods to offset the fall in real wages, and the increasing cost of buying durable goods by businesses because the depreciation of durable goods falls on shareholders because of the low tax rates the global corporations can chose. Consider Apple and Google who have billions in profits sitting legally offshore outside the developed productive economy. If they bring them back to the US to buy productive assets, they must pay taxes, with the government paying for half the depreciation in tax deductions. But buy keeping the cash offshore in an undeveloped economy, buying productive assets will be a cost born entirely by shareholders. If the productive assets in the undeveloped economy only generate 1% ROIC, that is not worth the investment given bringing the same cash back to the US nets out to a 2% ROIC after the government share in paying for depreciation is accounted for. Of course, a tax break for investment would boost the ROIC to 4%, but that means you have than much more cash to deal with.

One could do a Jeff Bezos and exponentially invest (and slash margins to paper thin to keep growing market share) to avoid paying taxes and not have cash stuck in a tax haven. But what is Bezos end game - when Amazon is 100% of all retail in the world, then what?

Obviously high profits stuck offshore kept in cash is a superior strategy compared to the Amazon do anything to grow market share so all profits can be invested in productive capital assets.

So what if Apple and Google refuse to lend their cash to low wage workers so they can afford to consume stuff they can't pay for. Government needs to support the poor by borrowing so the poor can spend because investing is productive capital assets is unprofitable and only idiots like Bezos pursues that dead end strategy.

At least we no longer have economists calling for taxing consumption to promote investment. We now know that Reagan's tax and spend was radical leftist - it was an outrage for the gas tax to be increased by 125% to reduce consumption so government could create jobs that were mandated to be paid at the sticky real and rising nominal prevailing wages that would build productive assets like transportation infrastructure. See

I think what we need at tax rebates for consuming. Sales taxes should be negative. Then nominal wages can fall because you get more money in your pocket from the government when you invest more wisely than government in a vacation in Spain instead of wasteful spending on new bridges.

mulp, I think the argument is that since nominal wages will not fall, businesses will respond by laying off instead. Instead of cutting wages 12% in 2007, businesses cut payroll 12% by laying off. Hiring only comes back as inflation slowly creates a decline in real wages so maybe today that company has hired everyone back, but at 2007 salaries which represent a 12% cut.

The implication is if only we could get flexible wages, we'd solve the unemployment problem. This may be true but we'd still have a Recession problem. Recessions are not increases in unemployment but declines in GDP or income.

As Krugman points out, and I have to hate to agree with him. Even if wages are fully flexible you will still have debt that is bound nominially. So you need both flexible debt and prices.

Both of these are hard to do, and for multible reasons buissness dont do it. So it is a much better idea to fix the nominal target instead. Once you fix that, recessions will maybe not in the past, but any recession would be some kind of real shock.

Why didn't Japanese wage cuts work?

The Japanese had a system where some one-third to one-half of everyone's annual wages was paid in the form of a bonus that could be cut or eliminated without labor fighting it.

In several post-WWII recessions it worked beautifully.

But when the Japanese bubble burst the major wage cuts did not seem to have any impact.


The final sentence is exactly right.

would the last sentence be better as [the nominalist approach] "is ***complicatedly*** becoming less effective" as time passes... ?

Not sure why you think this is "exactly right." Scott, you seem to think: (i) we can fix a goal, say 5% NGDP growth; (ii) achieving that is feasible; (iii) that will fix all our problems. I think (ii) and (iii) are incorrect.


Why dont you think (ii)? We have some of the leading montary thinkers saying the same thing (Woodford). We a major central bank leader (in England) saying the same thing.

Where does Scott say (iii)? He say that both in the US and in Japan the montary policy could be better but there would still be a real, specially for japan.

The recession of the early 80's was a because of high inflation. Household balance sheets tended to be in good shape because of, in part, the appreciation in home prices during the inflationary periods. Just as an example by parents home in Denver appreciated from about $15,000 in 1965 to about $75,000 in 1983 and I think that was probably typical. But new housing starts had been constricted by 13-14% interest rates. As interest rates dropped housing starts boomed and consumer credit expanded, driven in part by refinancing. And this increase in demand would lead the market to respond by offering more supply through more investment.

In 2008 the housing market was a disaster that we have not yet recovered from. My parents house declined from $180.000 to about $110,000. and is now about $130,000. Again not atypical. And equity in homes is much lower than 30 years ago.

Existing homes are still priced below the replacement cost of a new home in much of the country so housing starts are only about half of what they were in the 80's recovery. So household balance sheets are constricted and the demand for other unsecured credit, such as credit cards, has seemed to plateau as it would inevitably have to. It could not grow at a rate higher than inflation forever. This lack of demand will inevitably constrict investment. Despite the shortage of investment inflation is lower than in the 80;s and supply shortages are unheard of so incremental investment will probably not be profitable.

You often mention that more and more people are working part-time/temp jobs.

Temp jobs definitely are playing a role here. I'm not going to give an annual 2% raise on $10/hour. It doesn't have the same moral force as if the person were to be paid a regular salary. Anyway, by the next year, chances are the person will have moved on and someone else will take the $10/hour job. Such is the nature of temp work.

Higgs has a nice article on sluggish investment over at the Independent Institute. He suggests regime uncertainty as the cause. I would add to it high corporate taxes and massive regulations that raise the internal rate of return hurdle.

Wages never need to fall in industries that are doing well in a recession while in industries most damaged by the recession, such as housing and autos, the demand for the products has fallen so much that workers couldn't find jobs if they offered to work for free. They have zero marginal productivity for those industries.

Lose monetary policy only makes things worse as it destroys the risk/reward ratio for banks. Add the increased scrutiny by regulators and banks are unwilling to lend.

Higgs piece sounds like medieval obscurantism, which is typical of Austrian economics. Excerpt below, note "regime uncertainty" (neologisms are the hallmark of Austrian obscurantism--and chess literature like Hans Kmoch's Pawn Power in Chess) A case could be made along the lines of Krugman that the longer the lack of a recovery, the more it points to a lack of demand that can be 'cured' by a dose of inflation. Put another way: structural changes are not abrupt, but happen over time, while a change in demand is caused by fear, a fear to spend money, that can be cured by a dose of Zimflation.

Higgs: "The current situation is not simply an artifact of wounded banks’ reluctance to make new loans; many businesses are in a position to invest in long-term projects by using low-cost internal financing, but they are not doing so. Something else must be invoked to account for the bloodlessness of investors and entrepreneurs during recent
years. I have repeatedly suggested that regime uncertainty deserves serious consider-ation in our attempts to understand the economy’s present sluggishness" HAHAHA You cannot be serious, except maybe in Syria.

The trouble with these economic theories is that they are comprehensive but implausible. The Real Business Cycle theory for example amplifies the tiniest perturbations. Along these lines, the stock market "Crash of 1987" was caused by obscure proposed changes in the US congress, or, as here with this Keynesian approach, tiny changes in wage cause massive unemployment. I am reading a paper by Arnold Kling that tries to come up with a sort of Austrian interpretation of the economy, called "PSST", where there is no one AG/AS curve for the entire economy, but a myriad number, depending on what job you are in, but even this approach reminds me of "comprehensiveness by obscurity". Excerpt: "Another important difference between PSST and conventional macroeconomics is that the latter draws a sharp distinction between cyclical unemployment and structural unemployment. PSST treats all unemployment as structural. For conventional macroeconomics, structural unemployment is just a phenomenon that always exists in the background. It is not a factor in cyclical swings in unemployment." (Kling). But this is probably just another misguided attempt to square the circle. Economics is nonlinear.

Related to price stickiness, I see two theories being somewhat discredited by the last 5 years. One is the theory you mention. It makes no sense to claim that recessions take place because prices are not flexible enough due downwards. Price rigidity cannot explain 5 years. People are not out of work for 80 weeks because they are asking too much.

I also think this is evidence against the idea that all a recession needs is a requilibration of prices. The story is much more complex than a shock happened, therefore prices will equilibrate supply and demand so we will be back to "normal". The basic AD-AS model fails.

Both undergrad econ theories are on shaky ground, especially after this recession. I think it's been illustrated that some powerful friction, besides price rigidity, is in the economy which has stalled the equilibrium at below average growth.

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