Price and wage stickiness during the Great Depression

Abstract

This article examines the relative importance of sticky wages and sticky prices in explaining the length and the depth of the Great Depression. Econometric evidence shows that the supply failure was an outcome of widespread price stickiness and that wage stickiness only played a minor role as a propagating factor during the first years of the Depression. Microeconomic evidence suggests that there was widespread and increasing industrial concentration during the interwar period. There is a general consensus among most economists that adverse nominal demand shocks had severe and long-lasting employment and output effects during the Great Depression because rigid labour markets prevented wages from adjusting to the declining price level. Using cross-country data Eichengreen and Sachs (1985) show that the depth and the length of the Depression across countries was strongly influenced by cross-country changes in real wages. Their evidence shows a clear negative cross-country relationship between the change in industrial production and real wages over the period from 1929 to 1935. Using a more formal panel data approach, Bernanke and Carey (1996) reinforce the finding of Eichengreen and Sachs. Most individual-country studies also find that wages were slow to adjust to the nominal demand shocks. Beenstock and Warburton (1986) find strong evidence for wage stickiness in the UK and Dimsdale et al. (1989) show that wage inertia and mismatch in the labour market played an important role in the propagation of the Depression in the UK. Similarly, Bordo et al. (2000) find that the monetary shock was propagated by sticky wages for the US. The studies of Cole and Ohanian (1999, 2001) and Hanes and James (2003), however, fail to find any evidence for widespread wage stickiness during the first years of the Depression. Cole and Ohanian (1999, 2001) show that the detrended real wage in the US between 1929 and 1933 decreased by almost 15 per cent for the whole economy, and they argue that the sticky wage hypothesis is inconsistent with the evidence for the US. Furthermore, based on simulations of the Phillips curve estimated on postwar data in the US, Hanes and James (2003) show that the actual and the simulated wage