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Paul Krugman: Sticky Wages and the Macro Wars: Noted

Paul Krugman: Sticky Wages and the Macro Wars:

Simon Wren-Lewis… makes the case that downward nominal rigidity of wages is simply a fact… 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… don’t understand the significance of this observation….

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…. 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.

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