Tyler Cowen calls sticky wages a weak and embarrassing paradigm

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.  Ifthat 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.

So growing up in the New Keynesian paradigm I learned that sticky wages don’t make sense because the real wage is pro-cyclical. That is, in contrast to Keynes’s suggestion labor is actually cheaper during recessions than during booms.

This moved the story to sticky-prices. Here the core idea is that the economy is dominated by firms with some measure of market power.  Such firms always want to sell more at the market price than the market will demand.

This makes a lot of sense in causal empiricism because almost no business seems indifferent to more customers. A perfectly competitive firm would not really care at the margin if it had more customers.

However, in practice almost all firms are constantly consumed with how to get more customers. This only makes sense if they have some sort of market power.

However, if they do have market power then sticky prices mean that when aggregate demand falls, firms can have increasing amounts of excess capacity.

The question is why would prices stick.

One idea is that there are menu costs or a limited number of time that a firm can adjust prices.

Another is that adjusting prices often imposes real costs for customers.

Another is people have limited attention and/or price increases trigger search.

Another is that there are some prices which are especially sticky for special reasons and this sticks the whole system – that’s part of my interest in real estate.

Another is that debt is nominal and solvency constraints cause stickiness. Lower your prices too much and you can’t pay your debt. This latter point makes a whole lot of sense but it suggests that adjustable rate debt should stabilize the system where in fact it seems to be destabilizing.

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