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There is a well-regarded theory in economics (and popular?) that suggests that during slack economic conditions, we should welcome a bit of unexpected inflation from the Fed. Why? Well, for one, if you believe in a sticky wage view of the world, and the psychological and practical difficulties with employers lowering wages to existing workers, then by having a dose of unanticipated inflation, that reduces real wages without firms actually having to lower the amount on a paycheck.

Think about this for a moment. A very well-regarded (scientific consensus?, I don’t think so, but go with it for now …) idea is that we need to see real wages fall as a way to expand employment. Implicit in this, of course, is that employment is sensitive to changes in real wages. Now, my personal view is that this is NOT the limiting factor in hiring so that even if we halved real wages we would not see a tremendous jump in employment, at least not in the short run.

But think about the implications of this view. Employment is sensitive to decreases in wages.

Now think about the popular view that minimum wage increases do not reduce employment (by the way, I find it odd that people expect a priori that it would, but that makes me weird I guess … a future post is coming about this). In other words, employment is not sensitive to increases in wages.

So, here we have two alternative views of the world. When we are wearing our macro-policy hats, it turns out that wages and employment actually move quite a bit together, but when we put on our micro-policy hats they don’t. I don’t see how these both can be true. OK, I CAN see it, but I find it hard to reconcile without some fantastic jujitsu reasoning.

One Response to “Price Stickiness, Illusion, and the Impacts of the Minimum Wage”

  1. Tyler M says:

    This is an awesome post. Especially considering how the sticky wage model is what we learned in Prof. Chang’s class today!

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