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Saturday, October 02, 2010

How Sticky are Prices Right Now ?

The academic debate about macroeconomic policy is very different from what it was in the 80s. Keynesians have gone hard core, as is appropriate given safe short term nominal interest rates. Their opponents have debated their claims about nominal aggregate demand. Back then, the counter-argument was either than increased nominal demand just causes increased prices with no real effects (except when in a liquidity trap) or that expectable increases in nominal demand just caused increased prices.

A huge debate is not so much settled as forgotten. As far as I know, no one is arguming that wages and prices will adjust so as to cancel fiscal stimulus. Now there is one good Keynesian reason for this, the AD curve may be vertical so the price level has no effect on real aggregate demand. An increase in the price level reduces aggregate demand by reducing real balances (the real value of the money supply) and maybe that just doesn't matter right now when money and tbills are considered perfect substitutes. But I mean really, that sort of argument never stopped them before.

I think the reason is that firms will clearly not increase prices if their costs haven't increased and they can't sell as much as they would like. Their costs are wages and other prices. Prices won't go up much. They also don't seem to be going down. It seems clear that firms are very very reluctant to cut prices.

This means (as noted by many including, of course, Paul Krugman) that prices are extraordinarily sticky right now. Many firms seem to be at the point where they are no where near inclined to raise prices or to cut prices. Thus the pricel level is at a sticking point. Yet somehow some people fear inflation. We must tell them
"Screw your courage to the sticking point."

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