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.com - licensed to ETH Zueriction between inflation and unemployment.Unemployment characterizesrecessions; booms are plagued by inflation as aggregate demand hits the limit.palgraof potential output.Keynesian theory is often reformulated in terms of aggre-gate supply and aggregate demand, just as individual markets are modeled asom wwwthe interaction of suppliers and demanders.If aggregate demand is higherthan aggregate supply and there is no slack in the economy, the price levelwill increase, that is, inflation will appear.If aggregate demand is lower thanaggregate supply, deflation will occur and unemployment will develop.Theyright material frpolicy prescriptions were summarized in the so-called Phillips curve, whichCopdescribed a trade-off between inflation and unemployment: the authoritiescould run fiscal and (in certain cases) monetary policy so as to target full-employment at the cost of some inflation, or fight inflation at the cost ofsome unemployment.This theory was shattered in the late 1970s and early1980s when both unemployment and inflation increased simultaneously.Theunemployment rate jumped from 5.5 percent in 1974 to 8.3 percent in 1975and to nearly 10 percent in 1982 and 1983.Consumer prices simultaneously10.1057/9780230118478 - Somebody in Charge, Pierre LemieuxFebruary 4, 201119:27MAC-US/CHARGEPage-519780230112698_04_ch0252●Somebody in Chargeincreased, by 11 percent in 1974 and up to a peak of 13.5 percent annualinflation in 1980.30Besides the contradictory empirical evidence, there are many theoreticalreasons to doubt the claim that deficiencies of aggregate demand will naturallygenerate recessions.Wage rigidity is a complex issue.Many empirical studies seem to confirmthat nominal wages are sticky downward, that they are much more easilyincreased than cut.31 Even during the first two years of the Great Depression,real wages increased instead of falling.Casual observation of the milder recentrecessions points to the same direction.32 During the 2001 recession (March-November 2001), for example, average hourly earnings in the United Statesincreased by 2.1 percent, which, given the CPI (consumer price index, anindex of prices in a typical consumer’s expenditures) increase of 0.8 percent,veConnect - 2011-04-01translates into an estimated increase in the real wage rate of 1.3 percent.Sim-ilarly, over the whole 2007–2009 recession, average weekly earnings increasedalgraby 5.5 percent while the CPI gained 1.9 percent, for an estimated increase ofh - P3.6 percent in the real wage rate.33So wages do seem to be sticky downward, even in periods of unem-ployment.Why? One set of explanations revolves around the concept of“efficiency wages”: to get better workers, goes the theory, each employerpays wages slightly above the minimum he has to pay, so that the gen-eral level of wages is always a bit above what would otherwise be itsequilibrium.And when a recession strikes, firms don’t cut money wagesrapidly: even if they are legally allowed to, they prefer to fire less produc-tive workers and make sure that the ones retained are happy and motivated.34veconnect.com - licensed to ETH ZuericAnother reason why money wages may not adjust rapidly is that they areoften fixed by long-term or implicit arrangements between employers and.palgraemployees.35It is indeed because wages are sticky downward that we observe unem-om wwwployment during a recession.When prices (wages in this case) don’t adjust,quantities (employment) adjust instead.On this, Keynes was partly right.Wage inflexibilities should not be exaggerated, though, especially in theAmerican economy, where the labor market is more flexible than in otheryright material freconomies.The oft-cited evidence from other countries36 should be partlyCopdiscounted.And as time passes and the unemployed put pressure on wages,the latter must drop at some point.The longer the recession, the more pres-sure will be exerted on wages, just as happens with prices of goods andservices.Indeed, real wages did drop in 1932 and 1933,37 and they showeda tendency to fall in the middle of 2008.The question is how much time ittakes, but it should be remembered that, historically, most recessions do notturn into depressions.10.1057/9780230118478 - Somebody in Charge, Pierre LemieuxFebruary 4, 201119:27MAC-US/CHARGEPage-529780230112698_04_ch02Keynes’s Old Clothes●53Note that, when nominal wages start decreasing, prices should not dropas much proportionally, so that real wages will go down and the quantitydemanded of labor will increase.We can think of at least two reasons for this.First, wages are only one component of cost, so that a 10 percent drop inwages should not automatically translate into a 10 percent price drop.Sec-ond, even assuming that workers get lower wage incomes in total (becausethe elasticity of the demand for labor is such that employment increases lessthan wages have decreased), it does not follow that aggregate demand will bedeficient, pushing prices down further, as Keynes argued.For whatever pro-duction the laborers don’t buy, other owners of factors of production (ownersof capital and land) will buy, for somebody must have received the incomefrom the increased production that accompanies higher employment.38Moreover, the inflexibility of nominal wages often come from institu-veConnect - 2011-04-01tional or policy constraints.Both Hoover’s encouragements to businessesto maintain wages and Roosevelt’s National Industry Recovery Act exertedalgraupward pressures on wages, thereby deepening the depression.39 In today’sh - Pworld, wage inflexibility is increased by the legal powers of trade unions toimpose inflexible collective agreements—although these powers have recentlybeen on a downward trend in the private sector of the United States andother countries [ Pobierz całość w formacie PDF ]