Economics and Politics by Paul Krugman - The Conscience of a Liberal - NYTimes.com

Economics and Politics by Paul Krugman - The Conscience of a Liberal - NYTimes.com:
...money has real effects precisely because it pushes against sticky nominal wages.
...The way this channel works in standard models ...is that a rise in the real money supply reduces interest rates, leading to a rise in demand; and a fall in nominal wages for a given money supply would have the same effect. What happens when you’re in a liquidity trap, with short-term interest rates up against the zero lower bound?

Well, the answer in a simple model is that falling wages and prices can still be expansionary, but only because they reduce current prices relative to expected future prices, and thereby generate expected inflation. [But] once you add in debt-constrained players, it’s likely that the effect actually goes the other way: a fall in wages worsens debt problems, and so ends up contractionary.

...Some of us encountered a closely related question back in the late 90s, when thinking about the Asian financial crisis. It seemed obvious that there were big problems when people had large foreign-currency debt: a depreciation of the rupiah, say, worsened balance sheets by causing the domestic-current value of debt to explode, and was probably contractionary overall. But this did mean that no amount of depreciation would be expansionary? No; as I wrote in a little paper at the time, once everyone who could go bankrupt had, any further depreciation would be expansionary. So a sufficiently large depreciation could restore full employment.

Similarly, you could argue that a sufficiently large fall in wages could restore full employment now — but it would have to be a very large wage decline, and the positive effects would kick in only after deflation had first driven just about every debtor in the economy into bankruptcy.