sticky wages and downward nominal wage rigidity

Sticky Wages and the Macro Wars by Krugman

Simon Wren-Lewis, following up on Bryan Caplan, makes the case that downward nominal rigidity of wages is simply a fact, attested to by overwhelming evidence. Furthermore, it’s a fact that we understand fairly well in terms of behavioral economics. So he suggests that the unwillingness of many macroeconomists to incorporate this fact in their models — because it doesn’t have “microfoundations” — says something disturbing about the state of the field.  

He’s right, but I have the sense that many of his readers — and just about all of Caplan’s commenters — don’t understand the significance of this observation for the history of macroeconomics over the past 40 years.  

You see, the question of wage (and price) stickiness, and hence of real effects of changes in nominal demand, was what the great rejection of Keynesianism was all about. And I mean all about. Back in the 70s, there was hardly any discussion of the determinants of nominal demand; what Lucas and his followers were arguing was that Keynesianism must be rejected because it was unable to derive wage stickiness from maximizing behavior.

Lucas initially argued that unexpected nominal shocks still mattered, because people couldn’t initially distinguish them from real shocks, but that this offered no room for useful policy. Later, freshwater economics rejected even that proposition; the business cycle was all about real shocks, with demand playing no role at all.

At no point was this rejection of Keynesianism driven by superior empirical performance; it was all about the principle, about refusing to incorporate anything that wasn’t derived from maximization all the way.

So you can’t say, “Well, OK, maybe people aren’t hyperrational, and wages really are sticky” and then go back to hating on Keynesians. Grant that one point — as you should, because the evidence is overwhelming — and you’ve conceded, whether you know it or not, that much of macroeconomics spent three-plus decades following a blind alley.

I see that some of Caplan’s commenters are willing to accept that nominal demand matters, but draw the line at “nonsense” like the liquidity trap. Well, the zero lower bound is also a fact, and once you start admitting that demand matters, you’ll find yourself inexorably arriving at liquidity-trap analysis. But leave that for another day. The key point here is that to concede the obvious about nominal wages is, like it or not, to concede that Lucas, Prescott, and so on were just a great detour away from useful macroeconomics.

and

Wage Flexibility in Doctrine and Policy (Wonkish)