As we all continue to grumble, fight and shout about raising the minimum wage to $15 an hour or not a very clever point made by Bryan Caplan some time ago. If you really are a Keynesian then you must therefore also believe that the minimum wage causes unemployment. Because built into that very idea of Keynesianism is the idea that prices are sticky, and that those sticky prices for labour create unemployment. That's why we have the whole idea of fiscal policy, fiscal stimulus, being a useful reaction to a recession. It really is foundational: but then if you do believe that then a minimum wage does exactly the same thing. And thus that minimum wage must increase unemployment.
Here's Caplan:
If you're even mildly Keynesian, you know that downward nominal wage rigidity occasionally leads to lots of involuntary unemployment. If, like most Keynesians, you think that your view is backed by overwhelming empirical evidence, I have a challenge for you: Explain why market-driven downward nominal wage rigidity leads to unemployment without implying that a government-imposed minimum wage leads to unemployment. The challenge is tough because the whole point of the minimum wage is to intensify what Keynesians correctly see as the fundamental cause of unemployment: The failure of nominal wages to fall until the market clears.
To unpack that into simpler terms. While this assumption is more notable in New Keynesian models it is there in the original and is a point made by Keynes. So, something nasty happens to the economy. Could be either a supply or a demand shock. Great, the older Classical economics just assumes that all prices change to take account of that and then on the economy goes. Sure, maybe everyone's poorer, maybe wages have fallen but we very quickly return to full employment and growth, having adapted to that shock, simply because prices react quickly.
Keynes and Keynesians say that it doesn't quite work like that. We humans are subject to the money illusion. We'll let our real wages decline, even if unhappily, for example if inflation is higher than wage growth. But we get really, really, unhappy if our nominal wages fall. So, in a recession, when there's not going to be much inflation anyway if any at all, wages won't fall to the new level required by whatever our shock was. Simply because we strongly resist falling nominal wages. And that's why all the intervention is necessary. Because we can end up wallowing around in a recession for years because prices don't adjust quickly.
Of course, you can say that prices really do react quickly, even instantaneously so there. But then you're not a Keynesian, you're a New Classical or perhaps a Real Business Cycle type. You would also, if you said that, be pretty much saying that recessions cannot happen in which case what the heck just happened over the past few years?
So, wage rigidity creates unemployment, at least in recessions, as it means that wages do not react quickly enough to shocks to the economy. And what is a minimum wage other than legally mandated nominal wage rigidity? So, therefore, if you believe in the money illusion story, in sticky prices and nominal wage rigidity, all things you pretty much do have to believe in order to be a Keynesian, then you should also be believing that the minimum wage will, at least in a recession, cause unemployment.
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