The Dining Room Table Responds
By Bryan Caplan
Penny: He’s a really good-looking guy, and I thought he was kind of
cheesy at first…
Billy: [quietly] Trust your instincts.
Penny: But, he turned out to be totally sweet. Sometimes people are
layered like that. There’s something totally different underneath than
what’s on the surface.
Billy: And sometimes there’s a third even deeper level and that one is
the same as the top surface one.
The story so far:
The Paul Krugman of 2009 objects that cutting wages reduces Aggregate Demand, so cutting wages won’t help.
I reply that cutting wages actually increases Aggregate Demand, so it will help.
Then Krugman gets frustrated, repeats that I’m “simply assuming that a rise or fall in nominal wages is equivalent to a rise or fall in real wages,” and says that he feels like he’s “arguing with a dining room table.”
My reply to his reply: I’m not simply assuming that nominal and real wages rise and fall together. What I’m saying, rather, is that the secondary effect on Aggregate Demand that Paul emphasizes is, in all probability, positive rather than negative. If labor demand is elastic, then lower wages imply higher labor income, and higher AD. And even if labor income falls, employer income goes up when wages fall, so AD could still easily rise as a result of lower wages.
I’ll admit that counter-examples are conceivable. Consider the polar case where labor demand is perfectly inelastic. If wages go down by 10%, employment stays the same, so labor income goes down by 10%. Employer income goes up by an equal amount, so the net effect on AD depends on the marginal propensity to stuff income under one’s mattress. If that propensity is higher for employers than workers, then AD goes down; otherwise, it still goes up. The key thing to notice about this example: You need bizarre assumptions to get the result that Krugman treats as normal.
If he had a pile of empirical evidence on his side, I could at least understand Krugman’s doubts about the common sense position. But all he’s got is a theoretical curiosity in search of an empirical anomaly; straightforward historical and contemporary tests support the standard view that wage cuts are the cure for unemployment.
Bottom line: I may be a dining room table, but Krugman doesn’t have a leg to stand on.