“Wage and/or Price Stickiness?” Illustrated

In his post on Wage/Price  stickiness Scott Sumner writes:

So my solution is to return to basics, apply the simplest model that is useful for policy.  Start with why we care about all this—unemployment.  If we had recessions without a change in the unemployment rate, or even hours worked, economists would have never even invented the AS/AD approach to macro–they’d investigate real shocks.  We developed modern macro to explain why employment seems to fluctuate in a suboptimal fashion.  So let’s start with the labor market; why doesn’t it clear?

And as soon as we begin to look at the labor market, a solution jumps right out at us.  NGDP is highly erratic, and nominal hourly wages are very stable.  Hence hours worked moves in the same direction as NGDP, over the cycle. (Of course in the long term nominal shocks have no real effects.).

The images:


And continues:

One counterargument is that perhaps the nominal shocks (NGDP fluctuations) are actually real shocks, combined with a central bank policy of targeting inflation. In that case there might be no causal relationship running from NGDP to employment.  Rather it might go from real shocks to real GDP to employment, with NGDP merely going along for the ride—as inflation is stabilized.  But that’s why monetary history is so important.  We don’t just know that NGDP and employment are highly correlated, we know that NGDP shocks caused by insane monetary policies and employment are highly correlated.  That’s the smoking gun.

The images:

Stickiness_2Note that in the 1973-75 cycle, impacted by commodity/oil shocks, the correlation between NGDP and employment is absent.

And when NGDP is shocked by monetary policy, W/NGDP becomes very countercyclical, almost certainly because nominal wages are sticky.

The images:

Stickiness_3The only exception is again the 1973-75 supply shock recession in which case, as Mark Bills pointed out, W/NGDP was highly procyclical, consistent with the absence of an NGDP-employment correlation.

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