Created: 2000-03-05
Last Modified: 2000-03-05
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Price Rigidities and the Great Depression

J. Bradford DeLong



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?

My Comment:

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:

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...


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Professor of Economics J. Bradford DeLong, 601 Evans Hall, #3880
University of California at Berkeley
Berkeley, CA 94720-3880
(510) 643-4027 phone (510) 642-6615 fax

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