Final answer:
Falling nominal wages cause the short-run Keynesian aggregate supply curve to shift right, leading to an increase in output to the full employment level. The speed of these adjustments is debated, but they are crucial to the neoclassical understanding of economic recovery.
Step-by-step explanation:
Over the long run, falling nominal wages will shift the short-run aggregate supply curve to the right, which causes output to increase back to the full employment level. From a neoclassical perspective, when there is a higher level of unemployment, employers can hold wages steady or lower them due to the increased availability of workers willing to accept lower wages. This decline in wages, being a price of key input, means that the short-run Keynesian aggregate supply curve shifts right from its original position (SRAS) to SRAS₁, leading to an increase in output without upward pressure on the price level. Eventually, the macroeconomic equilibrium shifts, and the level of output returns to potential GDP.
How fast these adjustments take place is a matter of debate between Keynesian and neoclassical economists. Nonetheless, in the neoclassical view, even if these adjustments take years, this perspective remains critical for understanding the economic adjustments and the return to potential GDP in the long run.