Conservatives better hope that wages and prices are sticky
By Scott Sumner
Macroeconomists are often lousy political philosophers. In previous posts I’ve discussed how macroeconomic views that are considered “liberal” or “conservative” actually have no obvious relationship to those political stances. For instance there’s no obvious reason why “using monetary policy” (as Milton Friedman preferred) is less interventionist that a countercyclical budget deficit (as Keynes preferred.)
One of the most amusing examples of this phenomenon is the critical reaction to Friedman and Schwartz’s Monetary History of the United States. When the book first came out the message was viewed as being “conservative”. Thus the Great Depression (in their view) was not caused by the inherent instability of capitalism, but rather by bad monetary policy. All of the statist interventions of FDR were not needed, and indeed were often counterproductive. (That’s still my view.)
By the 1990s, however, it was liberal economists who defended the book against conservative critics. By the 1990s, many of the right had moved past monetarism to flexible price “equilibrium models’ of the business cycle, AKA, real business cycles. Keynesians kept insisting that because of sticky wages and prices, aggregate demand shocks still matter—and pointed to the Monetary History as supporting evidence.
If you survey the field of macroeconomics, circa 2017, you see economists on the left almost unanimously acknowledging that wages and prices are sticky and that demand shocks have real effects on output. On the right side of the spectrum, there are people like Greg Mankiw, John Taylor and I who believe that wages and prices are sticky, but also a large group who are skeptical about whether wage and price stickiness is a key issue in the business cycle.
In fairness, the stickiness skeptics hold views are often fairly nuanced, with some acknowledging price stickiness as a factor, but doubting its importance. Still, it’s clear that on average the skepticism over sticky wage/price models of the business cycle is far more pronounced on the right than on the left.
An outsider might naively assume that this political dichotomy occurs because wage and price stickiness is what Al Gore would call an “inconvenient truth” for those on the right. Nothing could be further from the truth. I am mostly on “the right” in my economic philosophy, but that’s only because I believe wages and prices are sticky. If someone convinced me that they are actually flexible, I might be inclined to become more of a socialist.
I believe that a combination of sticky wages and monetary shocks produce most of America’s economic slumps, including the Great Contraction of 1929-33, as well as other big recessions like 1920-21, 1937-38, 1981-82 and 2008-09. I do not believe the capitalist system is “inherently unstable” and that big government is needed to stabilize it, rather I believe that it is naturally stable, as long as bad monetary policy doesn’t interact with wage stickiness to produce business cycles.
But suppose it were shown that I am wrong, and that wage/price stickiness is not an issue—what then? That would be very bad news for my laissez-faire ideology. Now I’d have to concede that events like the Great Contraction of 1929-33 showed that capitalism is indeed inherently unstable, and that this problem could not be fixed with good monetary policy. Now I’d have to entertain other solutions, such as big government and or comprehensive economic planning.
To be fair, the real business cycle view that “technology shocks” cause business cycles is not necessarily identical to the left wing view that capitalism is inherently unstable. What RBC economists call ‘technology shocks’ could simply be bad economic policies by the government. And in my view they sometimes are bad policies. The NIRA caused the recovery to stall from July 1933 to May 1935, while Nixon’s wage price controls led to an artificial boom in1972, and then a deep recession after they were removed and workers sought catch up pay increases.
But my reading of economic history is that it not possible to develop a general theory of the American business cycle based on bad government policies. Indeed even where bad policies play a role, such as Hoover’s policy of high wages, high tariffs, and high taxes, they don’t even come close to explaining the 1929-33 downturn. The same policies during a period of stable NGDP growth would have simply meant a bit of stagflation. And lots of periods of “big government” policies are associated with strong growth, such as the period of LBJ’s Great Society (1965-69).
So thank God that the right is wrong about wage/price stickiness! It is a major issue, and when combined with bad monetary policy it leads to economic instability. Without wage price stickiness it pretty hard to argue in favor of conservative economic policies. The Great Depression directly led to immense human suffering and indirectly led to WWII, which caused even more suffering. Those things simply cannot be allowed to happen. Without wage price stickiness, the right would not have any persuasive arguments against those who want to use much more interventionist policies to prevent economic Depressions.
Without wage/price stickiness, capitalism really would be inherently unstable.