I believe it is more or less consensual that increased
nominal rigidities contributed to the high unemployment
and large output declines of 1929-1934, and that these rigidities
had increased over the pre-1914 period. But everyone talks only
about *wage* rigidities, which is certainly important and appropriate
given the unemployment problem.
However, what of nominal *price* rigidities? Why is it
not in the literature? Why do so much get placed on nominal *wage*
rigidity and unionization (much of which came *after*) and so
little on price rigidities?
Most of the technical economic literature on nominal rigidities
and depressions (especially the Great Depression) starts out,
as economists tend to do, from a perfectly flexible-price competitive-market
general-equilibrium-optimality "classical" baseline,
and asks what went wrong--what market failures in the structure
of the economy led to these sharp falls in production and sharp
rises in unemployment.
From this starting point the natural thing to do is to look
at the commodity in excess supply--labor--and ask why its price--the
real wage, the nominal wage w divided by the price level p, w/p--did
not move far enough and fast enough to restore equilibrium. Why
didn't the collapse in demand lead to enormous falls in real
wages that kept employment nearly full? (Albeit at the price
of a collapse in the working class standard of living--a "distributional"
issue with which economists tend not to deal much.) The answer
given is then "nominal wage rigidity."
Along this path, nominal price rigidity is not a problem but
a benefit. If the key puzzle that you are looking at is what
keeps the real wage "too high"--what keeps it from
falling far and fast enough in a depression--to preserve near-full
employment, something that keeps final goods prices from falling
accelerates rather than retards the "classical" adjustment
mechanism. I think this is the reason that people focus on nominal
wage rigidity--they are working within a problematic focused
on the causes of depression unemployment, and within which the
counterfactual baseline is a "classical" one in which
near-full employment is preserved in spite of a collapse of aggregate
demand because of a sharp fall in the real wage.
Of course, once one takes the fact of wage rigidity as an
institutional datum, the argument then spirals off into all kinds
of directions: the relative effectiveness of fiscal vs. monetary
policy, whether aggregate demand and aggregate supply are independent
or whether wage flexibility would cause destabilizing deflation
and universal bankruptcy, etc., etc.--things I have worried about
in:
http://www.j-bradford-delong.net/pdf_files/Stabilizing.pdf
http://www.j-bradford-delong.net/pdf_files/Defining_Moment_Draft.pdf
http://www.j-bradford-delong.net/pdf_files/Peacetime_Inflation.pdf
http://www.j-bradford-delong.net/pdf_files/Stabilizing_Reply.pdf
http://www.j-bradford-delong.net/pdf_files/Eichengreen_Hatton_Review.pdf
http://www.j-bradford-delong.net/pdf_files/Liquidation_Cycles.pdf
http://www.j-bradford-delong.net/pdf_files/Keynesianism_Pennsylvania.pdf
And the tradition that you are thinking in--one in which the
quantity theory M x V = P x Y governs, and in which, as M and
V fall, the thing that makes Y fall is that nasty monopolistic
corporations use their monopoly power to keep their prices P
fixed--was a live intellectual current during the 1930s, showing
up in places like the Temporary National Economic Committee and,
if I recall correctly, some of Thurman Arnold's pronouncements
on the macroeconomic importance of successful antitrust policy...
At any event, these are my thoughts this morning. But I reall
should get back to grading my make-up exams...
Brad DeLong
Professor
of Economics J. Bradford DeLong, 601 Evans Hall, #3880