Morning reading, it might be good for me to type things down.
First, interesting blog here, nominal price rigidity is caused by coordination failure. In particular, if household have nominal debt, which is the stickiest price of all kind, we would rationally expect to have downward nominal and wage rigidity. A quote from Milton Friedman is interesting:
“The argument for a flexible exchange rate is, strange to say, very nearly identical with the argument for daylight savings time. Isn’t it absurd to change the clock in summer when exactly the same result could be achieved by having each individual change his habits? All that is required is that everyone decide to come to his office an hour earlier, have lunch an hour earlier, etc. But obviously it is much simpler to change the clock that guides all than to have each individual separately change his pattern of reaction to the clock, even though all want to do so”
Now we could also equally just ask everyone to accept nominal wage decrease, but keep the debt at the nominal level. However, compare with debt deflation, is the sticky wage solution better in terms of welfare?
Second, a recent new strand literature on the neo-Fisherian hypothesis, perhaps pioneered by Cochrane, is drawing new attention from two new-Keynesian economists, Woodford and Eggertsson. They find that the neo-Fisherian equilibrium is indeed one of the possible equilibrium in the standard new-Keynesian model, but the model is not very robust if we add learning. This post is possibly the most clear (to me). Currently Woodford and Eggertsson only has slides online. I look forward to read their paper.
I have read about neo-Fisherian, especially the articles by Cochrane. I have real difficulty reading Stephen Williams because I don’t know search theory that well. I personally highly doubt if the neo-Fisherian idea is going anywhere: Monetary policy is much about managing people’s expectations. Woodford 2012 in Jackson Hole has made this quite clear, and offers strong supportive evidence. Now neo-Fishersian is telling us: No! you should raise interest rates to bring up inflation. OK, if such policy is implemented, how would market participants react????
The neo-Fisherian idea does tell me one thing: the new-Keynesian models are not “right”, in the sense that there’s a continuum of equilibrium, and the way we choose the equilibrium is somewhat flawed. Maybe Krugman is right, simple IS-LM model is the best to understand what’s going on in the Great Recession.
Oh I almost miss this interesting reading from Delong