Long-Run Unemployment at Low Inflation: Dourado vs. Akerlof-Dickens-Perry
By Bryan Caplan
My friend and former student Eli Dourado has gotten a lot of attention for his recent post, “The Short-Run Is Short.” Key passage:
Around 40 percent of the unemployed have been unemployed for six months
or longer. And the mean duration of unemployment is even longer, around
40 weeks, which means that the distribution has a high-duration tail.
Now, do you mean to tell me that four years into the recession, for
people who have been unemployed for six months, a year, or even longer,
that their wage demands are sticky? This seems implausible.
What Eli doesn’t seem to consider, though, is the possibility of long-run unemployment when inflation is low. Akerlof, Dickens, and Perry’s “The Macroeconomics of Low Inflation” made a very strong case for this back in 1996. The last four years have strongly vindicated their position. Their key point: Firms are heterogeneous, so even when most firms are doing fine, a minority need to cut real wages. With modest inflation, these firms can cut real wages covertly via inflation. With low inflation, firms either have to cut nominal wages and incur workers’ wrath, or cut employment.
Akerlof, Dickens, and Perry’s paper is complex, but here are the results from a simple simulation. This table shows the fraction of firms that can only cut real wages by cutting nominal wages:
The result is a long-run inflation-unemployment trade-off at low inflation:
[T]he main problem isn’t that unemployed workers are “stubborn” about
their nominal wages. The crucial “behavioral postulates” are rather
1. Hiring new workers for lower wages provokes resentment and resistance from existing employees – the classic insider-outsider mechanism.
At this point, the unemployed will probably say “yes” to jobs even if
they they perceive their nominal wages as “unfair.” But after a brief
honeymoon period, these new workers would probably have low morale.
This wouldn’t just hurt their productivity; it would also bring down the
productivity of their better-paid co-workers.
One further point: If the marginal value product of low-skilled workers is falling as rapidly as Eli says, the Akerlof-Dickens-Perry story has added force. Even if most of the economy is doing fine, low-skilled real wages need to steadily fall if low-skilled workers are going to remain profitable to employ. With low inflation, maintaining this steady fall is like pulling teeth, year after year. The facts Eli points to are just what you’d expect to see in an Akerlof-Dickens-Perry world with Dourado-type polarization of labor productivity.