Menu Costs

I was pointed by Paul Krugman to a definition of New Keynesian Economics written by the right wing (New Classical) economist Greg Mankiw . Not being an economist, I found some of the discussion unbelievable. Here's the bit that really sent me over the top. I've bolded the key bit:

One reason prices do not adjust immediately to clear markets is that adjusting prices is costly. To change its prices, a firm may need to send out a new catalog to customers, distribute new price lists to its sales staff, or, in the case of a restaurant, print new menus. These costs of price adjustment, called “menu costs,” cause firms to adjust prices intermittently rather than continuously.

Economists disagree about whether menu costs can help explain short-run economic fluctuations. Skeptics point out that menu costs usually are very small. They argue that these small costs are unlikely to help explain recessions, which are very costly for society. Proponents reply that “small” does not mean “inconsequential.” Even though menu costs are small for the individual firm, they could have large effects on the economy as a whole.

I find it incredible that the New Classical economists hold that markets "clear". Looking at the current unemployment in the US, it is pretty clear that the labour market isn't "clearing". But these New Classical economists claim this massive and extended unemployment is due to "menu costs".

It is pretty clear that prices are "sticky" but "menu costs" is a strange way to explain it. To me it is got more to do with human psychology and social relationships, not something mechanical like the cost of printing a catalog. With the Internet I don't believe that "printing catalogs" is a real issue.

I think prices are sticky because people resist change. Companies have a hard time deciding "when" to change prices because it is never clear if they will stick. This is a psychological issue in the mind of the company decision-makers as well as in the minds of the price-takers who have to decide to accept the new price or go find substitutes or do without.

Companies don't "clear the labour market" by cutting wages because workers get resentful when their wages are cut. Even so, we've seen a lot of wage cutting in this recession. I don't see much real "stickiness" to wages. My personal experience as a worker is that you don't get to "negotiate" a wage. The company when it hires you offers you a take-of-leave-it offer. Annually you get another take-it-or-leave-it wage offer. There is no negotiating, and no "stickiness" caused by the worker. The stickiness of wages is purely on the company side worrying about "worker morale".

Reading through this entry by Mankiw I don't get any sense that economists have any kind of handle on the real world. They have lots of theoretical constructs, but they are about as useful as the Medieval theological debates which had lots of abstractions and theoretical constructs. Fancy language doesn't mean the stuff is of any value. The real test is "what is it good for" and "does it work?". And on both those counts, modern economics fails miserably.