Tuesday, 9 September 2014

Downward nominal rigidity and the minimum wage

I have just finished reading Tim Harford's most recent book, The Undercover Economist Strikes Back, which I would highly recommend. In contrast to Harford's similarly titled first book, The Undercover Economist, which was about micro-economics, his latest one is about macro-economics. (For readers unacquainted with the distinction between micro- and macro-economics, P.J. O'Rourke offers an instructive explanation: the former concerns things economists are specifically wrong about, while the latter concerns things they are wrong about in general.)

In the early chapters of his book, Harford deals with the topic of recessions, and in particular the phenomenon of downward nominal wage rigidity. This is where, during a recession, wages fail to go down when the demand for labour falls. One of the chief consequences is involuntary unemployment; because the price of labour remains constant, quantity drops further than it otherwise would. Nominal wage rigidity occurs for a variety of reasons, including menu costs, and the tendency for people to think in nominal terms combined with a belief in fair wages.

My question, which essentially just restates what Bryan Caplan has asserted several times, is as follows. Doesn't the existence of involuntary unemployment due to nominal wage rigidity constitute a fairly strong argument against the minimum wage? Indeed, as Caplan notes, it seems to constitute an argument for government interventions designed to actively push down wages during recessions. I'm genuinely interested to know the answer to this question; there seem to be many respectable Keynesian economists who are in favour of the minimum wage, which leads to the possibility that there is something that Caplan and I have missed.

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