Krugman defends

Or, at least, tries to defend himself.

Oy. Rajiv Sethi tries to make sense of the arguments of Bryan Caplan and Tyler Cowen. So I went and looked — and what’s immediately clear is that Caplan, at least, is simply assuming that a rise or fall in nominal wages is equivalent to a rise or fall in real wages.

This was exactly Keynes’s starting point: as he said, by taking it for granted that the bargain over nominal wages sets real wages for the economy as a whole, classical economists had “slipt into an illicit assumption.”

And look: if you work through my little AD/AS exercise it should be immediately clear that in the case I was concerned with, changes in W lead to equal changes in P, so that real wages don’t change. Simple microeconomic logic doesn’t help here at all.

The problem with Dr. Krugman’s defense here is that a) microecnomic logic is not relevant, and b) he has committed his own illicit assumption, for as he stated: “in liquidity trap conditions, the interest rate isn’t affected at the margin by either the supply or the demand for money – it’s hard up against the zero bound.”

But this means that even if one accepts his AS-AD model, it is obvious that he was incorrect to state that economy in the 1930s was hard up against the zero bound. As proof of this, he cites historical interest rates on 3-month Treasury bills as being 0.14%, and forgets that present interest rates on 3-month T-bills are around 0.005%. Moreover, his own calls for quantitative easing indicate that the zero bound cannot be the firm barrier that his model requires them to be.

On a less theoretical level, it is simply not credible to assert that a lower minimum wage is going to magically cause the Fed to raise interest rates. Japan’s highest minimum wage is lower than the U.S. federal minimum and this has obviously not caused Japanese interest rates to increase in 20 years.