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The Keynesian Gospel According to Modigliani 357
the main effect of non-cyclical budget deficits should be recognized as that of redistributing
resources between generations.
VI.6 Nominal Versus Real Wage Rigidity
In the analysis presented so far, we have supposed a sticky nominal wage that
does not decrease promptly in the presence of unemployment. This behavior was
seen initially as a cause for pessimism. For one could not count on wage flexibility
to provide an automatic offset to many potential internal and external
shocks. But in the 50s and 60s, that perceived rigidity became a source of optimism,
since it was believed that unemployment was principally of a Keynesian
type (that is, caused by an insufficient real money supply) easy to control through
the money supply (equivalent to real supply). The monetary authority (it was
believed) held in their hands the instruments needed to insure employment stability,
though there was a danger of an inflationary bias if the concern with unemployment
dominated the concern with inflation. And this story is consistent with
history from the 50s until the oil crisis—low unemployment but some inflation.
What happened in the 70s and 80s to cause the rising unemployment, reaching
dramatic levels in the 90s (11.5 percent for the Euro countries), and to replacing
that optimism with a wave of dark Euro pessimism on the feasibility of using
economic policy to keep unemployment within acceptable limits? And how can
these developments be reconciled with the Keynesian revolution and its promise
to cure forever the problem of mass unemployment?
I have labored for many years searching for an answer to this intriguing question.
But for lack of space, I must limit myself to summarize my findings by itemizing
five major causes for the unfavorable developments.
Very high on the list is: i) the transition (probably temporary) from nominal
wage rigidity to aggressive real wage targets, beginning in the late 60s but greatly
(though temporarily) reinforced, between the mid-70s and mid 80s, as a result
of: ii) the two great oil crises. During those crises, labor, confronted with the
sharp rise in the price of energy, endeavored to maintain a real wage target by
securing large increases in nominal compensations. But since productivity had
not increased, there was a surge in unit labor costs, which was passed on into
higher prices. That called for higher wages to maintain purchasing power which
led to more price increases and so on, igniting a typical wage-price spinal.
Now consider the predicament of the bank: keeping the money supply constant
would help tame the spiral but at the cost of a reduction of the real money
supply leading to rising unemployment. But trying to maintain the real money
supply by increasing the nominal one would have fueled the spiral, probably
without regaining control of the real supply, now at the mercy of an upward