Deflation Does Not Raise Employment
Paul Krugman:
Wages and Employment, Yet Again: [E]ven if we didn’t have that problem [that deflation causes bankruptcies because of nominal debt], there would be no reason to expect a general fall in wages to raise employment.... [D]emand curves usually slope downward... because when you cut the price of something, it normally gets cheaper relative to other things, leading people to redistribute their spending.... But when you cut the price of everything — which is more or less what happens when wages fall across the board — there’s nothing else to substitute away from. Yes, economics textbooks typically show a downward-sloping “aggregate demand curve”. But the reasons for that curve’s downward slope aren’t the same as for your ordinary demand curve. It’s a process that works like this: lower prices -> lower demand for money -> lower interest rates -> higher spending. And that process doesn’t operate when, as is currently the case, short-term interest rates (which are the ones that matter for money demand) are zero.
Things are different for a country that shares a currency with other countries. Ireland can raise employment by cutting wages of Irish workers relative to German workers. But America, with its floating dollar, gains nothing — nothing at all — from overall wage cuts. All we get is a magnified real debt burden.
