Insights from the new AER

Here’s a passage from a recent AER paper by Pierpaolo Benigno and Luca Antonio Ricci:

This paper offers a theoretical foundation for the long-run Phillips curve, by introducing downward nominal wage rigidities in a DSGE model with forward-looking agents and flexible-goods prices, in the presence of both idiosyncratic and aggregate shocks. .  .  .

Several important implications arise. First, the optimal inflation rate may not be zero, but positive, as inflation helps the intratemporal and intertemporal relative price adjustments, especially in countries with substantial macroeconomic volatility or low productivity growth. Second, the ideal inflation rate could differ across countries (and in particular it would be higher in countries with larger macroeconomic volatility and lower productivity growth), and may change over time. Third, stabilization policies can play a crucial role, as they can improve the inflation-output trade-off.

Additional theoretical implications arise. First, the overall degree of wage rigidity is endogenously stronger at low inflation rates and disappears at high inflation rates, unlike in time-dependent models of price rigidities where prices remain sticky even in a high-inflation environment. This arises from the endogenous tendency for upward wage rigidities (as in Elsby 2009), resulting from forwardlooking agents anticipating the effect of downward rigidities on their future employment opportunities. Second, this endogenous wage rigidity also introduces a trade-off between the volatility of the output gap and the volatility of inflation, as at low inflation adjustments occur mainly via changes in output and at high inflation via changes in wages. Third, the Phillips curve may arise not only from the need for intratemporal relative price adjustments across sectors in the presence of downward rigidities (as in the traditional view), but also from the need for intertemporal relative price adjustments, which open the way for the important role of macroeconomic stabilization policies discussed above. Fourth, nominal shocks can have high persistent real effects, suggesting that introducing downward wage inflexibility in a menu-cost model à la Golosov and Lucas (2007) would likely change their conclusion that nominal shocks have only transient effects on real activity at any level of inflation.

So there are models that predict persistent output gaps as a result of downward nominal wage rigidity, especially near zero inflation.  And remember we have conclusive evidence that nominal wages do exhibit downward rigidity, especially near zero inflation.

In the same issue of the AER, Peter Diamond has some interesting comments on the structural/demand-side debate:

Second, for the current moment, the argument about the aggregate demand side is academic, in the negative sense of the word. Current estimates I have seen of how much of the increase in unemployment from a few years ago is “structural,” rather than due to inadequate aggregate demand, still leaves enough need for aggregate demand stimulation that it is clear what direction is needed for further policies.

Third, I am skeptical of the value of attempting to separate cyclical from structural unemployment over a business cycle. When firms evaluate candidates for positions, they consider the quality of the match of available candidates, projections of the availability of new candidates, and the value to the firm of filling the slot. That is, the willingness to hire for a given quality of match depends on expectations about the profitability of investing in a new worker and about the likely pool of future applicants.

The tighter the labor market and the more valuable the filling of a vacancy, the more a firm is willing to hire a worker who is a less good match and who may need more training. In other words, a worker who might be viewed as structurally unemployed, as facing serious mismatch in the current state of the economy, may be readily employable in a tight labor market. The common practice of thinking about the extent of unemployment as a sum of frictional, structural, and cyclical parts misses the point that the tightness of the labor market affects worker quitting decisions and affects employers’ willingness to hire an applicant who needs more training. In so far as direct measures of frictional or structural unemployment are dependent on the tightness of the labor market, they have limited relevance for the design of demand stimulation policies. The idea that the US economy is not adaptable and capable of dealing with the need for skills and jobs to adapt to each other is peculiar, given the long history of unemployment going up and down.

Those are two themes I’ve emphasized.  Structural and demand-side problems are deeply entangled, indeed I think the problem is even worse than Diamond does–as he puts little weight on the UI benefit extension to 99 weeks.  And second, even if we have major structural problems, there is still a clear need for demand stimulus.

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9 Responses to “Insights from the new AER”

  1. Gravatar of Morgan Warstler Morgan Warstler
    18. August 2011 at 05:31

    I think Peter Diamond just said out loud he PREFERS firms hire a “less good match.”

    But the business guy in me thinks, “when I’m hiring a less good match, that’s a TERRIBLE situation to be in.”

    What we want is a situation that keeps workers on their toes. We’re a capitalist system, people are supposed to live with a bit of the fear.

    Co-workers should NEVER be forced to meet a “less good match”

    “Less good matches” should feel a far greater need to DANCE.

  2. Gravatar of Rien Huizer Rien Huizer
    18. August 2011 at 06:59


    Go out, visit the homeless and hire them. They may be good matches.

  3. Gravatar of Scott Sumner Scott Sumner
    18. August 2011 at 07:02

    Morgan, I like boom years, when I go to the grocery store checkout and see some sort of disabled person working there. I like an economy where everyone who wants a job can get a job.

  4. Gravatar of Rien Huizer Rien Huizer
    18. August 2011 at 07:03


    Got ahead of myself. Go out, visit the homeless and hire them. They may be good matches. Just like investments, a random walk. And you can always let them go. The difference between booms and busts is that in booms, people think like this, but there are not enough talented homeless, in busts, it is the reverse, so this is the time to strike.

  5. Gravatar of Morgan Warstler Morgan Warstler
    18. August 2011 at 07:52


    1. You just described a MARKETING COST, make Sumner feel good while he shops.

    If you care so damn much, why don’t you seek out the stores with handicapped people, build a list online, and encourage people to shop there? Have the handicapped guy paint for your house?

    Oh I get it, you care enough for everyone to pay more SO YOU CAN feel good “even the disabled have jobs!” but not enough to change your behavior “sumner pays more by himself for the personal satisfaction.”

    Very libertarian of you.

    2. when we have Guaranteed Income you’ll be able to see disabled people working without having to be at WalMart… who excels at finding productive uses for people at scale.

    And when there is a Guaranteed Income, the OTHER WORKERS don’t wonder why they are making what a the disabled person is making.

    The second question is then, why are you getting in the way of a us adopting Guaranteed Income? A budget crisis BRINGS productivity gains. Stop pretending otherwise.

  6. Gravatar of Morgan Warstler Morgan Warstler
    18. August 2011 at 08:03


    I WANT a program where everyone who wants to work, even the homeliness, the elderly, and the disabled… GETS A CHECK every week.

    But I want the check to come from the government. ALL OF US absorb the cost through taxes. It is a social guarantee.

    And then I want the government to auction off their labor to the private market starting at $40 per week. So that REAL PROFIT can be made on their labor.

    Prices go down, signals go up, we keep the cheap jobs here.

    And we stop printing money.


    Scott gets it WRONG.

    there is not a line with DeKrugman at one end and Mulligan at the other.

    Mulligan is MOST MORALLY CORRECT – everyone must be REQUIRED to work.

    So we must build a system that FORCES people to work (an auction process does this), and after we have done everything we can to reflect this virtue…

    THEN we are sure the problem isn’t structural, so we can listen to Sumner / DeKrugman talk about excess capacity.

  7. Gravatar of q q
    18. August 2011 at 08:06

    well look at it this way. the firm i work for is hiring one new person now, a replacement for someone who had been here seven years. looks like this will be the only hire in our group forseeably, and so we need someone with very, very specific skills as well as high intelligence. (we write software and support in-house software applications.) the specific skills are necessary because we have to cover a certain number of bases. if we had any expectation of hiring more in the next year or so, we would be much less specific on skills. if someone had, say, 2/3 of the specific skills we needed we’d think that we could get the other 1/3 with another hire. we probably wouldn’t skimp on intelligence though we could and have choose skills over intelligence in the past.

  8. Gravatar of Bababooey Bababooey
    18. August 2011 at 09:21

    the argument … is academic, in the negative sense of the word.

    What other senses of that word are there?


  9. Gravatar of Scott Sumner Scott Sumner
    18. August 2011 at 16:37

    Bababooey, Heh, I resemble that remark!!

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