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The Myth of Keynesian "Sticky Wages"

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Samuel Smith Posted: Sat, Jun 9 2012 3:22 PM

I haven't yet read much Austrian economics, so I don't know their position on the concept of sticky wages. This is just something that came to me as I walking back from University, the other day.

One of the primary reasons Keynesians argue for intervention is due to the "stickiness of wages". But, I don't even know if this premise is true, let alone if the solutions are effective.

I mean, let's look at the current economic crisis: the Government's position is that wages have remained pretty much flat, or increased slightly. Obviously, the Government's numbers are based on their convoluted measurements (I assume they factor inflarion... but only the CPI numbers), and would also include public sector employees.

The problems with these are immediately apparent: CPI massively underestimates inflation, and the public sector wages won't respond to the markets, thus, they would have a net positive effect on the average wage level.

I'm guessing (again, these are all assertions, though I'm pretty sure they're all provable with the right amount of Googling) that if we were to just take private sector wages, and use a much more reasonable measure of inflation (like the one used over at shadow stats), we would probably find that wages have actually decreased by a noticeable amount: indeed, this is obvious anecdotally, from people struggling to fill up their shopping trolley/car.

And this is despite everything that's put in place which artificially increases stickiness - income taxes, welfare programs, wage legislation, powerful unions.

Had these things not been in place, and prices remained constant, the myth of sticky wages would effectively be disproven.... is my guess.

 

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Wages are prices.  The Keynesian myth is that "wage" isn't synonymous with the word "price".

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Supposedly, Keynes never supported the idea of sticky wages. It's an idea of the "New" Keynesians (i.e. the Keynesian/neoclassical synthesis, or what Joan Robinson called "bastardized Keynesianism"). The "Post" Keynesians generally follow Keynes in rejecting it. See here.

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Yeah,

this is drifting a bit off topic: from what I have read Keynes himself tended to be closer to "Chapter 12 Keynesianism" and said he was not "Keynesian" when compared with most Keynesians of the time...

Krugman a "Chapter 1 Keynesian" seems to agree, and doesn't really care.  Which is a shame because the Chapter 12 stuff is actually interesting

 

I'll give links if people want.

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Keynes' main objection to a natural process towards full employment is not sticky wages, but that a reduction in wages in turn will lead to a reduction in the prices of outputs.  I.e. that even a reduction in nominal wages will not lead to a fall in real wages.  The notion of price stickiness predates Keynes.

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So the 'paradox of thrift' is the cornerstone of the entire General Theory

EDIT: Apparently it is a little bit different from the paradox of thrift:

"An interesting thing about the paradox is that it is not to be found in Keynes’ General Theory (1935). Keynes was indeed opposed to saving. He considered saving to be a social harm, and advocated policies to encourage spending and discourage saving. In particular, he argued that "up to the point where full employment prevails, the growth of capital depends not at all on a low propensity to consume but is, on the contrary, held back by it" (ibid.: 373).

Keynes did not, however, connect underemployment to shifts in consumption spending. He connected underemployment to a low level of consumption spending via the "secular stagnation" hypothesis. Supposedly, because of past economic growth there came to be a chronic excess of what planned saving would be at full employment over what investment would be at full employment. This hypothesis was massively contradicted by the post-World War II economic expansion, and has been long abandoned by Keynesian economists.

Keynes considered the consumption function to be relatively stable. Under normal conditions, shifts in "the propensity to consume out of a given income" were not considered to be of more than secondary importance (ibid.: 110). This point is made by Alvin H. Hansen (1953: 84), one of Keynes' most loyal followers. So why did the early Samuelson and other textbook writers make such a big deal out of the paradox of thrift?"

- Clifford F. Thies, 'The Paradox of Thrift: RIP' http://www.cato.org/pubs/journal/cj16n1-7.html

Can anyone expand on what's being referred to in the second paragraph of the portion I quoted?

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Keynes did not discourage saving.  Keynes well understood that production requires savings.  He just simply believed that at times entrepreneurial expectations would be such that savings would not be invested, meaning productive assets would not be put to use.  The real price of labor would not fall and there would be less than full employment.  Thus, the two main policy conclusions: lowering the rate of interest and public investment.  Btw, "spending" is not the same as consumption; spending can mean both consumption and investment -- both are forms of expenditure.

I'm not defending Keynes.  But, his theories were not as simple-minded as some people like to paint them.

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Keynes did not, however, connect underemployment to shifts in consumption spending.

One would think that underemployment comes from people losing their jobs because the public has lost interest in what they produce. If the world tires of pizza and decides to eat ice cream instead, the pizza shops will close, creating unemployment.

But Keynes didn't think so.

He connected underemployment to a low level of consumption spending via the "secular stagnation" hypothesis.

The pizza shops did not close down because people got tired of pizza, but because the world suddenly got flooded with pizzas, too much to possibly be eaten. This happend because of secular [=for everything] stagnation, as he goes on to explain.

Supposedly, because of past economic growth there came to be a chronic excess of what planned saving would be at full employment over what investment would be at full employment.

The economy had grown so well that the sum of all the money being made was just too much to spend. Now normally, once a person has enough money to more than fill his belly and have a roof over his head, he will use the extra money to try and make money, meaning he will invest it. But people had gotten just so rich they had more money than they needed to spend on consumption, and more money than they needed to make more money. Of course, nobody ever has too much to invest, because everyone wants to use his spare money to make more, but the problem is that  investment opportunities are limited. There are only so many profitable business ventures. Planned saving [=money not spent on consumption] has become more than planned investment.

So a developed economy which makes everyone rich contains the seeds of its own doom. People will become so rich they will have nothing to spend on and invest in, and will thus hide their money under a mattress. Why is this bad? Because the money in an economy is supposed to flow from the producer to his employees [which includes himself] and back to the producer, in the form of either buying his product or investing in his factory so that he can keep on going. 

But if people hide money under the mattress, he doesn't get the money he paid out returned and paid back in to his business. Meaning he made too much stuff. Meaning he will have to lay people off.

All this is Keynes' explanation of business cycles. Getting rich will make you poor, if you are a country as opposed to a person.  

This hypothesis was massively contradicted by the post-World War II economic expansion, and has been long abandoned by Keynesian economists.

Don't know about this part.

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Thanks for the explanations.   I've done some further reading and it seems that the 'propensity to consume' is Keynes' key assumption and the bedrock of his 'general theory'.  If the propensity to consume as he explains it is accurate, then his conclusions do seem to follow praxeologically.  Hazlitt does a brilliant job in The Failure of the New Economics at showing that there is no reason to assume a priori that the relative level of saving vs. consumption continuously rises with incomes (and Keynes apparently doesn't give one), and that in fact statistics demonstrate that even on empirical grounds there is no reason to believe that Keynes' concept of the propensity to consume is accurate, with the percentage of income devoted to consumption vs. savings essentially remaining flat even as incomes rise (anecdotally and theoretically, once above a certain level perhaps).  Not that Keynes was an empiricist, of course.

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