Even in the worst years of the Depression, the classical theory defined economic collapse as simply a lost incentive to produce. Mass unemployment was caused only by high and rigid real wages. The proper solution was to cut wages.

To Keynes, the determination of wages is more complicated. He argued that it is not realbut nominal wages that are set in negotiations between employers and workers. It is not a barter relationship. First, nominal wage cuts would be difficult to put into effect because of laws and wage contracts. Even classical economists admitted that these exist; unlike Keynes, they advocated abolishing minimum wages, trade unions, and long-term contracts, increasing labor-market flexibility. However, to Keynes, people will resist nominal wage reductions, even without unions, until they see other wages falling and a general drop of prices.

He also argued that to boost employment, real wages had to go down: nominal wages would have to fall more than prices. However, it would reduce consumer demand, so that the aggregate demand for goods would drop. This would in turn reduce business sales revenues and expected profits. Investment in new plant and equipment would then become more risky. Instead of raising business expectations, wages cuts could make matters much worse. If wages and prices were falling, people would start to expect them to fall. This could make the economy spiral downward as those who had money would wait as falling prices made it more valuable – rather than spending.