Barro, Krugman, Keynes and wage stickiness

Paul Krugman criticized Robert Barro writing

Update: I should also point out this, in Barro’s article:

John Maynard Keynes thought that the problem lay with wages and prices that were stuck at excessive levels. But this problem could be readily fixed by expansionary monetary policy, enough of which will mean that wages and prices do not have to fall.

Is it too much to ask that someone criticizing Keynes actually, you know, read Keynes — at least enough to know that he devoted a whole chapter to explaining why a fall in wages would not expand employment? Or that someone commenting on contemporary policy at least be aware that the whole reason we’re talking about fiscal expansion is that monetary policy has run out of room?

To be picky and display ultra nerdiness, I would like to note that Krugman got his citation a bit wrong. The chapter in question can only be Chapter 19 "Money-Wages" which comes after Chapter 18 "The General Theory of Employment Restated" and is explicitly a response to the natural critique of The General Theory that, if wages are flexible, involuntary unemployment is impossible.

However, the argument in chapter 19 is a bit feeble. Mostly Keynes argues that if one wants lower real wages it is better to drive up prices wtih monetary policy than to try to lower "money-wages" (nominal wages). He also claims that neither monetary policy nor wage cutting is a good approach to depressions because

Just as a moderate increase in the quantity of money may exert an inadequate influence over the long-term rate of interest, whilst an immoderate increase may offset its other advantages by its disturbing effect on confidence; so a moderate reduction in money-wages may prove inadequate, whilst an immoderate reduction might shatter confidence even if it were practicable.

Frankly that's not a convincing argument. At the UK Treasury they argued, among other things, that deficit spending would be bad for the economy because it would shatter confidence. Clearly confidence matters a lot, but if we allow anyone to declare him or herself the true profit of what the crowd will believe that the crowd will believe, we might as well give up debate and analysis and just make him or her economic dictator (fine by me for the duration of the crisis if the dictator were Krugman or Keynes brought back from the dead).

The valid argument, the argument to which Krugman appeals, does not appear in chapter 19 at all. It appears in, get this, the appendix to chapter 14 "The Classical Theory of the Rate of Interest" as a discussion of "the rate of interest in ... Ricardo's "Principles of Political Economy."

in the extreme case where money-wages are assumed to fall without limit in face of involuntary unemployment through a futile competition for employment between the unemployed labourers, there will, it is true, be only two possible long-period positions — full employment and the level of employment corresponding to the rate of interest at which liquidity-preference becomes absolute (in the event of this being less than full employment.)

Keynes says that flexible wages imply full employment unless we are in a liquidity trap. Keynes clearly considers the assumption that wages are flexible to be extreme and implausible, but he agrees that wage flexibility implies only two possibilities -- full employment and a liquidity trap.

Now really, even someone who actually "you know read Keynes"* might not remember that an appendix on the history of thought to a chapter on the rate of interest is key to understanding Keynes' views on the implications of wage flexibility.

*note how I have changed the meaning of Krugman by quoting him out of context. In context "read" was a present subjunctive (I think) in the present tense . Out of context it becomes a past perfect subjunctive (I think. I am fine with Italian grammar but never learned English grammar). As written it was to be pronounced "reed" and as quoted to be pronounced "red". Sneaky eh ?

update: Welcome economistsviewers. Also I have been a bit too kind to Barro as the argument in the appendix to chapter 14 isn't really the only time Keynes mentioned a liquidity trap. In Chapter 21 "The Theory of Prices," he asserts that wages have downward nominal rigidity and this is important. He also mentions what would happen if they were flexible

If, on the contrary, money-wages were to fall without limit whenever there was a tendency for less than full employment, the asymmetry would, indeed, disappear. But in that case there would be no resting-place below full employment until either the rate of interest was incapable of falling further or wages were zero. In fact we must have some factor, the value of which in terms of money is, if not fixed, at least sticky, to give us any stability of values in a monetary system.

So when asserting that there is nominal rigidity, he notes that less than full employment would be possible even if wages were flexible.

In Chapter 21 there is also a hint that low inflation in the 19th century was caused by persistent less than full employment due to "liquidity-preference" and ... well let's spin the tape

The tendency of the wage-unit was, as usual, steadily upwards on the whole, but the efficiency of labour was also increasing. Thus the balance of forces was such as to allow a fair measure of stability of prices; — the highest quinquennial average for Sauerbeck’s index number between 1820 and 1914 was only 50 per cent. above the lowest. This was not accidental. It is rightly described as due to a balance of forces in an age when individual groups of employers were strong enough to prevent the wage-unit from rising much faster than the efficiency of production, and when monetary systems were at the same time sufficiently fluid and sufficiently conservative to provide an average supply of money in terms of wage-units which allowed to prevail the lowest average rate of interest readily acceptable by wealth-owners under the influence of their liquidity-preferences. The average level of employment was, of course, substantially below full employment, but not so intolerably below it as to provoke revolutionary changes.

He concludes the chapter with "But the most stable, and the least easily shifted, element in our contemporary economy has been hitherto, and may prove to be in future, the minimum rate of interest acceptable to the generality of wealth-owners.[2]" the footnote reads "Cf. the nineteenth-century saying, quoted by Bagehot, that “John Bull can stand many things, but he cannot stand 2 per cent.”"

I think that John Bull had better learn to stand 2% and 1% too for that matter. The refusal to accept 2 % would be achieved by holding wealth as cash if the nominal interest rate were below 2%.

I'm sure Keynes didn't resist the tendency to give uhm Keynes the credit for the post WWII persistent low unemployment, but the logic of The General Theory suggests that the economy was helped by 2 key things. First a bit of inflation which reconciles a low real interest rate with the nominal interest rate required to get the money out from under people's mattresses, and, second, deposit insurance made checking accounts as good as cash enabling the banks to get the money to firms.