We know wages are extremely sticky, we just don’t know why

Here’s a story on found on Tyler Cowen’s blog:

They are a cornerstone of Chrysler’s unlikely comeback: 900 employees turning out a Jeep Grand Cherokee sport utility vehicle every 48 seconds of the working day at an assembly plant here.

Nothing distinguishes them from other workers at the Jefferson North plant, except their paychecks. The newest workers earn about $14 an hour; longtime employees earn double that.

…the advent of a two-tier wage system in Detroit is spiking employment for one of the country’s most important manufacturing industries.

Here’s what we know for certain about the US business cycle:

1.  If nominal wages are highly sticky, then NGDP slowdowns will raise unemployment.

2.  Nominal wages are highly sticky for at least some workers.

3.  The period after mid-2008 saw the largest NGDP growth collapse since the Great Depression.

4.  The period after mid-2008 saw a huge rise in unemployment.

Here’s what we don’t know:

1.  Why didn’t Chrysler cut all wages to $14?  Fear of strikes?  Efficiency wages?

BTW, I do realize that long time employees are more skilled on average.  But that sort of huge pay gap didn’t exist in the 1960s or 1970s, and thus I think we can assume at least a big part of it is “artificial” in some sense.

Marxists would argue that further pay cuts for infra-marginal workers would merely raise profits.  I believe some of the money would go to extra employees.  And as Nick Rowe showed, in the public sector all of it could go to additional jobs.  I’d also note that health care is practically the public sector.

In an earlier post Tyler Cowen asks this question:

1. For how long “” in today’s America “” can an AD-driven recession last?  At what point do even the Keynesians toss in the towel and say “By now it is a growth and structural problem, not mainly AD”?  After all, the private sector had a chance to create more M2 and it failed.  How sharp is the distinction between the short run and long run?

Great question.  If I were forced to argue against my theory of the recession in an Oxford debate, my top three arguments would be:

1.  Natural rate hypothesis.

2.  Natural rate hypothesis.

3.  Natural rate hypothesis.

It’s a great model, I believe in it, and it suggests nominal shocks shouldn’t last for more than a few years.  I’ve already argued for the “entanglement theory” of this recession (between structural and AD factors), but let me provide three reasons why I think that monetary stimulus would help three years after the 2008 crash, but would not have helped (much) three years after the mid-1981 collapse in NGDP growth:

1.  The problem of 99 week extended UI benefits.  Powerful monetary stimulus would lead to a quick repeal.

2.  The problem of money illusion.  It’s much easier to slow the rate of increase in nominal wages, than to cut wages outright.  In 1982 we needed to slow the rate of increase in wages.  Now we need to actually cut many wages, which is far harder even if the consequences for real wages are exactly the same.  After I made this comment in a previous post lots of commenters wrote in trying to provide a rational explanation for worker reluctance to accept nominal wage cuts.  I thought all their arguments were bogus, and it just confirmed my view that money illusion exists.  My commenters are really smart.  If even they have money illusion I think it’s safe to assume the broader public does as well.

3.  The problem of reallocation out of fields like housing.  More NGDP would reduce the debt burden and raise real housing prices.  This would reduce unemployment caused by construction workers having a hard time finding other jobs.  Of course I’ve argued that housing is not the main problem with the recession, but it is a problem.

None of these applied to the 1983-84 recovery, which was the best example of the natural rate in action.  The UI wasn’t raised from 26 to 99 weeks, there was higher trend inflation, and hence less need to cut nominal wages, and there was no big housing/debt crisis.  Even the minimum wage situation was slightly different.

I would take Tyler Cowen’s challenge, and direct it at Keynesian fiscal policy advocates.  Originally fiscal policy was justified on the basis that NGDP was growing slower than Ben wanted, but Ben would not fix the problem on his own.  On the other hand, he wouldn’t stop fiscal stimulus from fixing it.  I never quite bought the argument, although I find it defensible.  But for how long?  After all, it is a fairly convoluted way of looking at monetary policy, isn’t it?  Is it still true?  Is monetary policy still not reacting at all to NGDP growth trends?

PS.  I don’t follow Tyler’s M2 comment.  I think he means NGDP.  But the private sector can’t create NGDP, only the Fed can.  And they haven’t created enough to support many jobs without massive wage cuts.  And it’s hard to cut wages, as we’ve seen at Chrysler.


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81 Responses to “We know wages are extremely sticky, we just don’t know why”

  1. Gravatar of James in london James in london
    15. September 2011 at 12:34

    Advocating a policy based on money illusion is to advocate deceit. Deceit is unethical. Unethical policies are bad in themselves and lead to moral hazard. Moral hazard leads to outcomes that reduce utility. Ethics and utility almost always match up.

  2. Gravatar of John John
    15. September 2011 at 12:38

    I can’t believe Scott even mentions the Marxist argument that measures that increase profits but hurt certain employees such as outsourcing, machinery, or lowering wages are bad for the employment picture. He should have refuted it better. The refutation is simple, if the move is profitable, then the company shareholders gain more than the affected employees lose. With the additional proceeds, they can invest in their own company, invest in other lines of business, or consume more themselves. All three of these measures boost employment. Keep in mind that people save in order to consume or invest later so don’t think you can refute that rock solid case with the “hoarding” nonsense.

    Finally, about wage stickiness, how many laws and programs have been created to allow market levels of wage flexibility. No politicians promote flexible wages, quite the contrary. Second, some wage stability is optimal because if wages fluctuated like commodities, then workers would have to hold large cash balances to protect themselves from fluctuations. Third, wage stickiness (at least according to wikipedia) was largely a contribution of Keynes during the Great Depression, a time period when Herbert Hoover and later Roosevelt had deliberately encouraged or mandated businesses to prop up wages at the expense of profits. The issue of wage stickiness hadn’t prevented recovery in 1920-1 when the government did nothing about a very large deflation.

  3. Gravatar of grcridlan grcridlan
    15. September 2011 at 12:39

    Scott:

    I think what Tyler means by “creating M2” is the reinvigoration of private liquidity creation and lending; what the natives call the “shadow banking sector”. This is substitute for Fed liquidity, and hence could show up in NGDP.

    If this is the case, what is your view on why not? Why isn’t there an explosion in private lending? And to what extent have other Fed policies (I’m looking at you Interest on Reserves) impacted the growth of M2 by the private sector?

  4. Gravatar of Benjamin Daniels Benjamin Daniels
    15. September 2011 at 12:45

    The Fed is certainly not targeting NGDP and they don’t even seem to be even targeting inflation – so what can we do if the bank is only targeting *nominal interest rates*? In this world there is quite a lot of reason to believe that fiscal policy will in fact boost NGDP – whether because it boosts consumption directly (naive Keynesianism, but more attractive from a distributional perspective than a growth perspective); or because it addresses Tyler’s critique and actually seeks to expand investment/growth (which I think is more properly Keynesian anyway given his focus on infrastructure investments).

    While I’d *prefer* the bank to provide stimulus, and while I do believe that if the bank did it properly and forcefully there would be no room for fiscal policy, I think the present situation requires us to look for that second-best policy.

  5. Gravatar of Morgan Warstler Morgan Warstler
    15. September 2011 at 13:06

    MY GOD!

    Chrylser and GM were given to the UAW you boob.

    The answer is and ONLY is: Govt policy UNDER OBAMA creates sticky wages.

    Because government policy under Perry would be to bankrupt the company, cut off the old workers, and let the thing be recapitalized with ALL $14 per hour workers.

    —–

    Anyone who wants to print money is morally obligated to demand government policy that UNSTICKS wages as a matter of preference.

    And if you don’t do it, the the right is morally justified in doing whatever it takes to keep you from getting the Monetary policy you want.

    You can’t have it both ways.

  6. Gravatar of David Pearson David Pearson
    15. September 2011 at 13:13

    “It’s much easier to slow the rate of increase in nominal wages, than to cut wages outright.”

    Year-over-year real average hourly earnings were down 2.4% in August (on y-o-y inflation of 3.8%). Nominal wages were down .1% month on month. The rate of increase in nominal wages is slowing, and real wages are dropping quite steeply. Employment has not reacted.

    The problem is real wages have been stagnant for ten years. If the Fed produces faster nominal wage growth, will workers not notice their wages are being further eroded by inflation? I think their antennae might be finely attuned to how far their paychecks go at Walmart each month. In 1q2011, the answer was, “not far”, and consumer confidence plunged. Same in the spring and summer of 2008. Perhaps the next dose of attempted money illusion will produce a different outcome.

    Its one thing to reverse spiking real wages (to new peaks), as happened in 1933; quite another to reduce trough real wages even further without expecting some discomfort.

  7. Gravatar of ssumner ssumner
    15. September 2011 at 13:18

    James, You said:

    “Advocating a policy based on money illusion is to advocate deceit.”

    I believe murderers should be put in jail. There; I’ve advocated a policy based on the existence of murder. Is that unethical?

    Money illusions exists. I’m advocating the monetary policy that does the least harm given than money illusion exists. I’m not deceiving anyone.

    John, Wikipedia is wrong, Keynes did not cause wage stickiness. Hoover wasn’t a Keynesian.

    grcridlan, Yes, I understood that it would affect NGDP, that was my point. M2 is not important in and of itself, but only to the extent it affects NGDP. But the Fed controls NGDP. So even if the private sector does something that, ceteris paribus, causes a change in NGDP, NGDP won’t change because the Fed won’t let it change.

    There is also the fallacy of composition. Even if the private sector as a group could affect NGDP, no individual actor could affect NGDP. That means no individual actor has an incentive to do things that affect NGDP, for the purpose of affecting NGDP.

    Benjamin, You said;

    “The Fed is certainly not targeting NGDP and they don’t even seem to be even targeting inflation – so what can we do if the bank is only targeting *nominal interest rates*?”

    In 2010 the core inflation rate fell to 0.6%. That set off alarm bells and the Fed did QE2. Then inflation rose close to 2%, and the Fed abandoned QE for fear of higher inflation. That sounds a lot more like a central bank that targets inflation, than a central bank that only targets interest rates, and never uses other tools like QE.

    If you are right then Congress would be crazy to do fiscal stimulus. If the Fed is sabotaging the recovery as you say (via passivity), Congress should give the Fed a new mandate like NGDP targeting, level targeting, rather than do fiscal stimulus.

  8. Gravatar of ssumner ssumner
    15. September 2011 at 13:23

    Morgan, I know that.

    David; You said;

    “Year-over-year real average hourly earnings were down 2.4% in August (on y-o-y inflation of 3.8%). Nominal wages were down .1% month on month. The rate of increase in nominal wages is slowing, and real wages are dropping quite steeply. Employment has not reacted.”

    That strongly supports my point. Nominal wage growth is near zero, meaning many workers are who should be getting nominal cuts (like Chrysler workers) are not seeing cuts.

    I pay no attention to real wages because I pay no attention to inflation. What matters is nominal wages relative to NGDP per capita. NGDP per capita is up barely 1% since mid 2008, wages have risen more in nominal terms. That’s why we have unemployment.

  9. Gravatar of Morgan Warstler Morgan Warstler
    15. September 2011 at 13:28

    Scott if you repeated that part over and over, you’d probably help a number of your readers to grasp what you really mean.

    ALSO, it really wont kill you to talk about where the Fed would have raised rates 2002-2008 under a level target.

    Stop saying we can never recover 11% and admit to some degree we were going too fast.

    3% level targeted NGDP is far more likely to get conservative support than 5%, right?

    Maybe think through why that is.

  10. Gravatar of David Pearson David Pearson
    15. September 2011 at 13:31

    Scott,

    Since using NGDP-deflated wages is a novel approach, it would be nice to see a chart with a reasonably long time frame on the x-axis and a trend line. How far above trend are those wages?

  11. Gravatar of James in london James in london
    15. September 2011 at 13:32

    We are all mere deluded pawns in the hands of master macroeconomist chess players. I don’t think so. Money illusion doesn’t really exist, a laudable desire to cling on to what we have does exist, but can’t always be sustained at the expense of others unless the state lends a redistributive hand.

    Pursuing a policy based on the assumption that we have massive delusions is to promote deceit. It just can’t be right and must have negative cosewuences. You just have to find them.

  12. Gravatar of Morgan Warstler Morgan Warstler
    15. September 2011 at 13:51

    Drudge delivers:

    The Consumer Price Index rose 0.4 percent in August after jumping 0.5 percent in July.

    The number of U.S. homes that received an initial default notice — the first step in the foreclosure process — jumped 33 percent in August from July, foreclosure listing firm RealtyTrac Inc. said Thursday.

    —–

    Just GIVE THE WINNERS THE DAMN HOUSES and get it over with.

    It really annoys me, there is NO ONE hurt by foreclosure, except for their credit rating.

    Nobody losing their house has ANY equity in it. They have ZERO equity and are overpaying rent tot he bank (the mortgage).

    I’d much prefer Dems and the Tea Party JOIN TOGETHER and use the MERS violations to to clean up the credit reports of the injured AFTER they leave the house.

    They don’t get to keep the house (principal write down), but give them a do over. Screw the banks.

  13. Gravatar of W. Peden W. Peden
    15. September 2011 at 14:02

    James in London,

    If we didn’t have money illusions, then so much the better: employees who always thought in real terms would be willing to take nominal wage cuts. No sticky wages, no mass unemployment in a recession.

  14. Gravatar of John John
    15. September 2011 at 14:08

    I wasn’t saying that Hoover was a Keynesian Scott. I was saying that he believed that workers “purchasing power” had to be maintained in the face of the stock market crash of 1929. Government policy deliberately aimed at sticky wages during the depression. I don’t think it’s a coincidence that sticky wages became a much bigger deal in mainstream economic thought following this.

  15. Gravatar of grcridlan grcridlan
    15. September 2011 at 14:20

    Scott: You said:

    “M2 is not important in and of itself, but only to the extent it affects NGDP. But the Fed controls NGDP. So even if the private sector does something that, ceteris paribus, causes a change in NGDP, NGDP won’t change because the Fed won’t let it change.”

    Understood and agreed, also about the fallacy of composition.

    Yet: Fed activity is granular and reactive; to prevent M2 from affecting NGDP, the Fed has to observe the M2 growth, and take a policy response. Also, as we have noted, it is not backward-looking. It appears the Fed is interested in the change in the price level, not the price level itself. If we accept those assumptions, rapid expansion in M2 by the private sector would be able to nudge NGDP higher in the short term, with an eventual policy response ending growth and maintaining the higher trend, correct?

    [Looks around for a way for a small group of private actors to print money.]

  16. Gravatar of MTD MTD
    15. September 2011 at 14:26

    Regarding Tyler’s M2 comment: M2 has taken off like a rocket since August as NGDP expectations have collapsed. Thus, we have a surge in the real demand for liquid balances that looks a lot like late 2008 and before that late 2001. In other words, we are in the throes of an unchecked negative velocity shock (if the Fed were checking it, NGDP expectations would not be plunging and the real demand for risk free cash balances would not be exploding upward). Falling TIPS spreads and rising corporate bond spreads confirm this.

  17. Gravatar of Martin Martin
    15. September 2011 at 14:35

    David,

    I can’t give you a very long trend as these data are only since 2000, however:

    http://research.stlouisfed.org/fredgraph.png?g=2ed

    The blue line represents the difference between y-y (%) change in employment cost and y-y (%) change in NGDP.

    The green line is the percent change in the employment-population ratio. That is it stands usually around 60 percent and a one percent change means +1 to 61 and -1 to 59.

    As you can see a positive difference in employment cost (%) – NGDP (%) is accompanied by a decline in the employment and population ratio. And vice-versa.

    I don’t think this illustration would work outside the great moderation as GDP-growth was fairly unstable before, but for this period it nicely illustrates the point.

  18. Gravatar of David Pearson David Pearson
    15. September 2011 at 14:50

    Martin,

    Thanks. Yes, the chart shows employment was growing while NGDP-deflated labor costs were falling, and vice versa.

    However, the question remains:

    Assuming employment costs deflated by NGDP are still below trend (potentially far below on a 20yr basis), how would that explain mass unemployment? Isn’t it the area underneath your wage-minus-NGDP function that we’re interested in?

  19. Gravatar of Steve Steve
    15. September 2011 at 16:04

    Money illusion definitely exists in wages. I know lots of people who have the same salary as in 2006. But they’ve seen cuts in bonuses, stock options, 401K matches, healthcare payments, and T&E budgets. They’ve also seen increase in unofficial work hours (same work spread over fewer people, due to reduced staffing), or increase in official work hours.

    If you’ve ever seen a big company where management is cutting budgets, they will do EVERYTHING in their power to reduce compensation expenditures without cutting the stated base salary of workers.

    Oh, and companies can sometimes get away with “reduced” wages by refusing to give merit increases as young employees become increasingly skilled and experienced. I think the $14 / $28 per hour story is an example of that. I’ve actually seen some economists argue that we need more of what Chrysler is doing. For the life of me, I can’t understand the morality of cutting/freezing the wages for young people in order to preserve the wages for older people, but that is also happening a lot these days.

  20. Gravatar of flow5 flow5
    15. September 2011 at 16:19

    It is axiomatic that the smaller the degree of price competition in a market and the greater the degree of private unregulated monopoly power over prices and output, then the higher the amount of unit prices, the greater the tendency for restricted output and employment and the smaller the degree of downward price flexibility

    Current issue of Economist “Prices or jobs?”

    “An alternative would be to switch to targeting the growth of nominal gross domestic product. If the target were 5%, say, inflation of 3% would not interfere with monetary stimulus so long as real GDP was growing by less than 2%. The Fed toyed with nominal GDP in the past when it was searching for something more stable to target than the money supply. But a regime of this sort has several drawbacks: since the trend in real GDP varies, inflation would, too, presenting similar problems to a higher inflation target. It would also be harder to explain to the public”

  21. Gravatar of Steve Steve
    15. September 2011 at 16:20

    Expanding on my previous comment, often a young (22yr old) worker will get hired into services/manufacturing at $14/hour or engineering at $50K/year. Normally, those salaries would ramp up pretty significantly over the first 5 years as the workers gain experience, but today, companies have salary freezes which include no merit pay increases for young workers. So a 27yr old who started working in 2006 is still at intro pay levels, while the person who started a few years earlier is way ahead of them.

  22. Gravatar of Benjamin Daniels Benjamin Daniels
    15. September 2011 at 16:38

    Scott,

    You said: “In 2010 the core inflation rate fell to 0.6%. That set off alarm bells and the Fed did QE2. Then inflation rose close to 2%, and the Fed abandoned QE for fear of higher inflation. That sounds a lot more like a central bank that targets inflation, than a central bank that only targets interest rates, and never uses other tools like QE.”

    I don’t think this gives a complete picture of how the Fed acts. You can see clearly that the Fed allowed a sustained drop in inflation rates from 2009 until 2011 (http://research.stlouisfed.org/fredgraph.png?g=2eo) and only took action when it looked like the rate would head negative.

    This demonstrates that the Fed isn’t truly targeting inflation in a fashion that would completely offset fiscal policy – they’re ‘quasi-targeting’ it in a downwardly biased way. So as long as fiscal stimulus doesn’t push inflation above 2% it definitely won’t be offset by the Fed.

    Also, because the Fed has guaranteed to target interest rates at 0% for the next two years, it is significantly more difficult for them to tighten even if fiscal policy did push inflation above 2% – they don’t have a true ‘positive’ tightening mechanism available, but instead maintained the upper bound on inflation by halting their own expansionary policy. That commitment means that the Fed is unlikely to offset expansionary fiscal policy in the near future even if it did push inflation above 2%.

    I also don’t think that a new mandate is a good idea. My main concern is that it compromises the independence of the Fed to demand a change in behavior by statute. I think we are stuck with the institution we have, and while I, like you, think that the Fed is utterly failing on its employment mandate, we should be working with the tools we have and the behavior we can observe to compensate for that failure.

    If Congress is going to act, they can and should use expansionary fiscal policy.

  23. Gravatar of Benjamin Cole Benjamin Cole
    15. September 2011 at 16:48

    Excellent post by Scott Sumner—-and yes, man is not always rational. Ergo, decreasing wages through inflation is acceptable, but cutting wages is not.

    Cutting a worker’s wage is probably considered a punitive action. Many companies attempt to foster a “team” spirit, and keep morale up through collegial activities—–then turning around and cutting a worker’s wage is not considered square. It might fly if management and shareholders took slightly larger cuts alongside, but they never do. Ergo, wage stickiness.

    Inflation means an inanimate force decreased wages, and generally—-the worker has an option of stretching his wage by avoiding certain price hikes, where he cannot hide from a pay cut. I would rather be inflated down than wage cut, for sure.

    NGDP and inflation is the way to go.

    Ben Bernanke please read Scott Sumner.

  24. Gravatar of Steve Steve
    15. September 2011 at 17:03

    More on wage stickiness:

    I think we do know why it exists. There is a perceived insult, lack or respect, or morale damage that comes from cutting nominal wages. Companies typically give annual nominal wage increases as a function of merit or seniority, so a nominal wage cut is perceived as a demerit or demotion.

    Obviously this is a case of money illusion. And not all employees will feel insulted by a nominal wage cut. But enough will that companies won’t take the risk of nominal cuts if they can cut employees or expenses in some other way.

    Personally, I would accept a nominal wage cut, but I’d want to know that it’s indexed to something like revenues, the stock market, or house prices. Otherwise, I’d feel offended by a nominal cut, too.

  25. Gravatar of Morgan Warstler Morgan Warstler
    15. September 2011 at 18:29

    Steve the is NOISE.

    Look people, I gave the answer and Scott agreed. What more do you need to know.

    ASKED. ANSWERED.

    The UAW OWNS Chrysler and owns GM.

    I use this all the time as my argument for WHY unions are dying no matter what.

    Because when they became the majority owners they got together and decided to treat the new union members like dog shit… like management does…. every time.

    Marx fails because the seniors will molest the young boys – and if you don’t admit it – you are OBVIOUSLY a senior.

    Labor is labor.

    Who cares about labor?

    Not the UAW.

    So the is ONLY ONE REASON for wage stickiness.

    The government doesn’t ACTIVELY try to tear it down.

    Wage stickiness is no more real than the liquidity trap in Japan – they WANT deflation. A bunch of YOU want wage stickiness.

    So please STFU, stop your self-protective theorizing and give me my attaboys.

    —-

    The deal is simple, you let me and mine go at wage stickiness with an ax, and if you are right, I’ll shut up and you can run the world, but if I crater wages – you leave your profession, and find real jobs.

    Note to Scott: watching you and Tyler every once a while while, when they are drunk on loving you try to sneak a good rearward shagging in… is SUPER BORING.

  26. Gravatar of libfree libfree
    15. September 2011 at 18:31

    On the story linked to by Tyler, I think he predicted this but I can’t find the old post.
    1. As I understand it, the UAW is now a large stakeholder in Chrysler.
    2. The UAW is dominated by retired workers, followed by veteran employees.
    3. New employees represent a very small portion of the voting membership.
    4. New employees come from outside of the industry.

    The story that Tyler linked to suggested that these changes are permanent and I’d argue that they are very temporary(but very useful). While I was originally horrified that the UAW was put ahead of senior bondholders, this might have been a major contributor to partially reducing wage stickiness. Maybe the best solution for a firm entering a recession is to fire the least productive members, give ownership to a minority of skilled employees and then allow nature to take it’s course?

  27. Gravatar of Russ Anderson Russ Anderson
    15. September 2011 at 19:18

    Scott wrote: “And it’s hard to cut wages, as we’ve seen at Chrysler.”

    Is a unionized company a representative sample of the overall labor market? Even in the mid-70’s unionized workers were less than 30% of the workforce, today it is ~12%. Outright wage cuts (along with benefit cuts) are the norm for a significant number of workers, as are increased hours by salaried workers. And most unions are making concessions.

    One research paper (which I don’t have handy) showed that the US and Slovinia (!) are the only major countries where the average hours worked by employees went up in the great recession. From personal experience the average salaried employee in the computer industry increased their working hours from 40+ in 2007 to 50-60 in 2009-2010.

    When companies can cut their workforce by 10% and increase the hours worked by salaried employees (at no additional cost) to make up for it, what is their incentive to increase employment? When companies can cut employee wages _and_ have them work more hours, increasing corporate profits, what is the incentive for the company to hire more workers? Especially in the face of the Federal Reserve, as you like to point out, keeping NGDP from increasing? After all, reducing the unemployment rate reduces the company’s leverage to make their existing work force to work more hours for less money.

    “Sticky wages” for the most part have gone the way of company pensions.

  28. Gravatar of Morgan Warstler Morgan Warstler
    15. September 2011 at 20:20

    “Maybe the best solution for a firm entering a recession is to fire the least productive members, give ownership to a minority of skilled employees and then allow nature to take it’s course?”

    Maybe?

    No, you fool.

    The RETIRED workers run the UAW.

    Please explain how the most productive workers are the retired ones.

    or INSTEAD, just roll over show your white belly and give Morgan the win.

  29. Gravatar of KRG KRG
    15. September 2011 at 21:29

    Why would such cuts it go to extra employees when Chrysler can already produce as much as it needs to given the current amount of employees? And why hire more people when it’s likely that automation technology can do more work and require fewer people (who they’re now paying less despite higher productivity)? The only reason that Chrysler would hire more people is if it was profitable to produce more cars. The only way to make it profitable to produce more cares is to have more consumers with enough money in hand to buy more cars. IF Chrysler cuts everyone’s wages, there will be that many fewer people who can afford new cars (especially as such similar decisions spread out across the entire economy)

    This split didn’t used to exist because wages used to track better to productivity, but ever since the 70’s wages have lagged behind productivity, to the point that the median wage is half of what it should be, so people have used debt to make up the difference; big profits for the financial sector (which means more money being dumped into that in proportion to direct capital spending) until it all comes crashing down when the fact that a cheap credit card or a big mortgage is not really a replacement for a wage increase finally catches up with the overall economy.

    The people making most of the financial investments here already have more money than they can spend effectively- that’s why they’re swamping the financial markets with it to begin with. They’re already at the practical limits on consumption that time and physical reality impose, and the consumer market is weak enough that there’s little profit in capital spending, so it all goes into financial investments and market speculation instead.

    Cutting wages will only increase the downward spiral- fewer consumers, less need to produce, so fewer are workers employed, while technology reduces the need to hire even at the replacement level. Cutting wages in half, when they’re already half of what they should be to provide strong positive consumer feed back to encourage production will just serve to further complicate our problems, not improve them.

  30. Gravatar of KRG KRG
    15. September 2011 at 21:53

    Just to back that up with a quick bit of calculation:
    Lets say it’s 1000 workers, one car/minute, and $15/hour ($30K/year) and $30/hour ($60K/year)
    $15*1000/30=$500
    $30*1000/30=$1000
    MSRP on a Grand Cherokee is $27000, so that represents a price difference of less than 2%.

    But, for a family of 4, $30K/year is only about $8K over the poverty line, $60K/year is $38K over the poverty line. That’s a 475% increase in disposable income for that 2% swing.
    (Even more notably- that swing explicitly represents enough for that family to actually buy one of the cars it produces; the $15/hour folks don’t even meet the basic Fordism test here, once you factor in basic living costs.)

    And note that all of the rounding I did there made labor even more expensive, but we still see only a 2% cost increase that buys nearly 5x as much purchasing power to motivate more production, rendering that small increase completely negligible.

  31. Gravatar of Morgan Warstler Morgan Warstler
    15. September 2011 at 22:38

    KRG,

    You are a GENIUS! No wait, it’s just a bunch of words strung together.

    “The only way to make it profitable to produce more cares is to have more consumers with enough money in hand to buy more cars.”

    ROFL.

    By reducing the cost of the car, you increase this thing called “value” so demand for the car goes up. See KIA. See Hyundai. See Toyota. See Honda.

    Why do you think low cost labor wins?

    Remember in your model, it doesn’t morally matter if car builders can afford the cars they build, they all only have to be able to afford a cheap car.

    Hope this helps.

  32. Gravatar of FT Alphaville » Further reading FT Alphaville » Further reading
    15. September 2011 at 23:23

    […] The maddening sticky wages […]

  33. Gravatar of Lorenzo from Oz Lorenzo from Oz
    15. September 2011 at 23:31

    On the stickiness of wages: surely it should be approached in the same way Coase approached the question of “why are there firms?’ Find the key question (in Coase’s case how to people decide to create in-house or purchase in the market) and ask decision-makers what factors they weigh in their decisions.

  34. Gravatar of Martin Martin
    15. September 2011 at 23:58

    @David,

    “However, the question remains:

    Assuming employment costs deflated by NGDP are still below trend (potentially far below on a 20yr basis), how would that explain mass unemployment? Isn’t it the area underneath your wage-minus-NGDP function that we’re interested in?”

    Regarding the area, that’s a good point! I think I understand what you mean by that, however I think you’re assuming a longer memory in the ‘market’ than I do. I don’t think the relationship between the area and the pop-employment-ratio can last that long.

    I think that after a while an economy will adjust to a lower NGDP growth rate, this is basically what was done in the Volcker-recession: to ‘break the back of inflation’ NGDP was slowed, unemployment spiked and then unemployment/population-employment ratio slowly turned to ‘normal’.

    This brings me to your first point – I didn’t understand you at first there (perhaps the coffee kicked in) – you are assuming that wages are below trend based on the fact – I assume – that real wages have stagnated since the 70’s or so? In other words, you’re saying, wages are still too low, instead of too high?

  35. Gravatar of William William
    16. September 2011 at 04:55

    Scott,

    Could I trouble you for a take on this Matt Yglesias post?

    http://thinkprogress.org/yglesias/2011/09/14/319359/how-asymmetrical-monetary-policy-ensures-wage-stagnation/

  36. Gravatar of Russ Anderson Russ Anderson
    16. September 2011 at 05:08

    Morgan asks “Why do you think low cost labor wins?”

    Is that why the world’s economic superpowers are all low wage countries? Oh wait, they’re not. The economic superpowers are all high wage countries.

    Econ history 101: the British industrial revolution took off after they banned slavery. The reason is simple: industrial productivity is based on automation and higher wages increase the incentive to automate.

    The free states won the Civil War not because they had cheaper labor than slave states, they won because the higher price of labor encouraged more “labor saving” inventions and innovation. Cheap slave labor discouraged automation (the cotton gin was invented by a free state inventor). Automation wins out over cheap labor every time.

    A friend recently returned from Germany and asked, “How can a country with so much automation afford to pay such high wages?” I told him he answered his own question: only a country with so much automation can afford to pay such high wages. And only a country with high wages has an incentive for so much automation.

  37. Gravatar of David Pearson David Pearson
    16. September 2011 at 05:23

    Martin,

    I don’t about the 70’s, but at least since the 90’s (still in our memory?).

    In the 1930’s wages were far, far above trend relative to NGDP. Corporate profits were negative in aggregate and falling in 1932. The profit from a new hire appeared strongly negative.

    Today, wages are significantly below trend; corporate profits are at peak. The profit from a new hire appears strongly positive.

  38. Gravatar of KRG KRG
    16. September 2011 at 05:42

    “By reducing the cost of the car, you increase this thing called “value” so demand for the car goes up.”

    If you reduce wages by more than you reduce the price of the car, then you see demand drop not increase. Again look at the relative changes- an 80% loss of disposable income for a 2% price savings. You’re losing consumers at a rate that’s two orders of magnitude higher than you’re gaining from the slight price advantage from cutting their share of the returns on their productivity so steeply.

    Low labor costs can win in a microeconomic sense, but it’s at the expense of macroeconomic growth. We can certainly outsource the deflationary effects of low wages by forcing other countries to absorb the downsides of low wages, but then we shouldn’t be surprised at all that, despite the net volume of the deficit we run with them, they never manage to become equal strength consumers that can help create a virtuous cycle of increased production demands, instead using our debt to fund their economy as well as our own.

    China is going to be interesting to watch over then next few years as it becomes more and more tested to see if it can keep a lid on its potential consumer power or if the dam finally breaks, forcing it to have to figure out how to vent the spike in consumer power that would come from growing private wealth and a stronger currency.

  39. Gravatar of Morgan Warstler Morgan Warstler
    16. September 2011 at 06:04

    Russ, wrong.

    The US is a high wage country because we let our capital flow away globally and employ cheap labor where it finds it.

    If we had not done this we’d be shitty. Instead we rock.

    KRG,

    You are an idiot.

    AGAIN, it doesn’t matter if our auto workers CANNOT afford the car they build.

    REPEAT THAT out loud to yourself.

    What matters it that our autoworkers can buy A car – a cheap car. When they can’t afford a $14K KIA, let me know.

    We want our cars to compete in value with KIA, BMW, Toyota. Period the end.

    Look you are making an error, it is giving you distress, I can help you get over it. In normal pricing you get 80% of the top line functionality for 20% of the cost.

    $4 lb cheese vs. $20 lb cheese
    $100 phone vs. $500 iphone

    You can use this 80 / 20 rule all the time to calm yourself down.

    The value of the bottom 20% cost is ALWAYS the best value. Functionality for cost wise.

    So when you get on your moral high horse about workers being able to afford things, realize it ends when they can buy the $100 phone, the $4 lb of cheese, of the $14K car.

    That’s what we are concerned with.

  40. Gravatar of Jason Odegaard Jason Odegaard
    16. September 2011 at 06:39

    Morgan, Scott, – I thought that sticky wages were just because individuals do not like to see the nominal value of their wages go down. An emotional aversion to reduced nominal wages.

    And inflation helps ease wage adjustment, since nominal wages do not have to fall near as much if the overall price level rises, causing real wages to fall.

    Isn’t this basically how monetary policy can help work through the unemployment caused by sticky wages? Help me see what I am missing if there’s something else at play.

    PS – I know there is probably something to risk preference and investment choices when monetary policy is firmly targeted on NGDP growth (reduced preference for cash), but I’m really just thinking about the sticky wages part now.

  41. Gravatar of John John
    16. September 2011 at 06:52

    Russ Anderson,

    You have cause and effect backwards there. Labor saving devices increase the marginal productivity of labor which determines real wages. More productivity= more goods available= greater purchasing power. Labor saving devices lead to higher wages not the other way around. If you were to go to a poor country and tell them to pay their workers higher real wages, you would only create large scale unemployment.

  42. Gravatar of KRG KRG
    16. September 2011 at 07:44

    Our capital doesn’t flow away- it stays right here, underutilized. Our money flows out and utilized or even acquires and brings home the capital of those other countries. Money is not capital, it is just the tool we use to employ capital.

    “What matters it that our autoworkers can buy A car – a cheap car. When they can’t afford a $14K KIA, let me know.”

    They alerady can’t- their disposable income at $15/our is $8K, about half of what they’d need to afford that $14K car. And even then, it’s irrelevant, because by buying that $14K car, they’re putting themselves out of a job because they’re feeding back less purchasing power than it requires to buy the product that they’re trying to sell. So now the economy is imputed even further to only those that get paid to make the $14K cars, who can, at best, afford half as much at the people who were making the $27K cars were (and you’re imagining fungibility where it doesn’t exist- you can’t fit a family of 4 into a Smart car, not matter how much better the price point may be). A construction contractor won’t be able to use a Kia Rio to move the tools and materials that he needs. Value comes from personal utility, price just gates access to that utility. If someone is offering the same value at a lower price, you’re right, but your statement doesn’t hold for different values at different prices, especially because value is a personal construct, not an objective one. And even if that worker happens to decide that a cheaper car does provide the right price to value benefit, that worker still has enough additional money to spend on other products to still provide a total economic motion that’s proportional to the price of the product, creating at least enough potential of someone else to buy the product at that price, or, better more money than it would take to buy that product so as to create a virtuous cycle.If the workers net production is taking more out of circulation than it puts in because the worker’s disposable income is less that the cost to purchase the product of it, you get a viscous cycle as overall circulation decreases.

  43. Gravatar of grcridlan grcridlan
    16. September 2011 at 08:17

    @William:

    The graph is interesting, but I don’t think it means what Matt thinks it means. Saying that X data series is below trend more often than it is above trend isn’t a criticism of the data series: it’s a criticism of the trend line.

    Also, Yglesias appears to be living in a Pre-Friedman monetary regime, where one can effectively “trade off” on the Phillips curve, unemployment for inflation. That isn’t, as the last forty years of scholarship and policy clearly explain, entirely accurate; there are limits to the Fed’s ability to do that, defined by market expectations of inflation.

    This is not to say that the Fed should not be printing more money. It’s just to say that the graph Yglesias presents does not tell us the Fed should be printing more money.

  44. Gravatar of grcridlan grcridlan
    16. September 2011 at 08:25

    @KRG

    I’m not a fan of Morgan’s rhetoric, but I don’t follow your criticism. A $14K car represents a financing charge of $1400 a year (at 10%), plus a four year payoff of $3500. That means that a worker with $8K disposable income could buy a new Kia every four years (more often than I buy cars) with more than a third of their disposable income left over.

    Also, money that is not paid out in wages does not disappear into the ether; it is retained as earnings (presumably for investment) or paid out in profits. There is literally no difference (from a “circulation” perspective) between paying the workers $28 and $14. It’s a purely distributional difference which should have no significant effect on AD.

  45. Gravatar of MikeDC MikeDC
    16. September 2011 at 08:29

    lots of commenters wrote in trying to provide a rational explanation for worker reluctance to accept nominal wage cuts. I thought all their arguments were bogus.

    What’s so rational about willingness to accept a nominal wage cut? A reduced nominal wage sharply reduces both my present and future value of my consumption options. Accepting a lower real wage by working more hours for the same pay does not.

  46. Gravatar of grcridlan grcridlan
    16. September 2011 at 08:35

    Also @KRG:

    You said:

    “If you reduce wages by more than you reduce the price of the car, then you see demand drop not increase. Again look at the relative changes- an 80% loss of disposable income for a 2% price savings. You’re losing consumers at a rate that’s two orders of magnitude higher than you’re gaining from the slight price advantage from cutting their share of the returns on their productivity so steeply.”

    False. It is a mathematical identity that the money doesn’t simply go away. It is redistributed from car makers to car companies and car buyers.

    You don’t lose consumers faster than you gain them because there are more than two orders of magnitude more car buyers than manufacturing employees. .02 times 1M is more than .8 times 54.

  47. Gravatar of Morgan Warstler Morgan Warstler
    16. September 2011 at 08:37

    KRG,

    You are conflating two of my points.

    First, it is a fact that there are people not worth what they need to live. They can’t earn it. ROI on their labor is impossible at the wages you want them to make.

    So now that we know they are going to need their living paid by taxes as safety net… it frees us to force them to work for what they are worth on the global labor market.

    Being an American makes you special, being an American worker does not make you special.

    Your problem is that you want to use the free market to delivery social welfare. You want to insist that since people need X they have to be worth X to an employer.

    Stop it and we can work out a way to make sure everyone has enough. Enough = 20 in the 80 / 20 rule.

  48. Gravatar of KRG KRG
    16. September 2011 at 08:55

    @grcridlan

    Worker could indeed do that, but first you now have loss to the rent on that loan, but even more than that, you have the problem that that worker’s product is demanding $27K from the economy while that worker can, at most, only put $8K back in (and it’s worse than that, really, because it assumes that only one car/worker needs to be sold in a given year to fully move his portion of the production.

    “Also, money that is not paid out in wages does not disappear into the ether; it is retained as earnings (presumably for investment) or paid out in profits.”
    If the profits were all going into capital spending or consumption, it would work out (note that in my calculation, I left all costs and current profit margin as static, letting the difference in wages go directly into the sale price of the car, so the amounts of those are the same regardless of pay)

    But with rapidly diminishing consumer power relative to prices, the company is not going to be spending money on expansion, so capital is out the window, and the vast majority of money that it then chooses to send to investors similarly goes into the hands of people that are already saturated for their consumption and expansion desires (except for the desire to attract more money without risking it on production when no market exists) so basically settles into either market speculation of financial products which search harder and harder for people who want to take out loans, generally having to lower standards to do so, because it’s only those low disposable income folks that are actually not saturated and thus looking for additional money.

  49. Gravatar of KRG KRG
    16. September 2011 at 09:13

    “You don’t lose consumers faster than you gain them because there are more than two orders of magnitude more car buyers than manufacturing employees. .02 times 1M is more than .8 times 54.”

    Every consumer gets an income from somewhere. Each of those potential buyers is in the same boat because the same logic that leads Chrysler to cut wages leads the rest to do the same. In fact the fundamental premise above was that labor prices would scale back across the board if it weren’t for them being so sticky. Remove that stickiness factor, and the entire consumer market (aside from a small handful at the top of the heap, which quickly saturates its ability to consume) loses the same degree of power.

  50. Gravatar of KRG KRG
    16. September 2011 at 09:20

    “First, it is a fact that there are people not worth what they need to live. They can’t earn it. ROI on their labor is impossible at the wages you want them to make.”

    You’re confusing nominal price and value. The opposite is actually true- the baseline wages they make sets the baseline for what the ROI on any given investment is, with diminishing returns once you get out of impoverished and into middle class status. Pay them the wages I suggest, and the very fact that they can afford more means that there are more profits to be made across the board by supplying those demands. The relative valuations still exist, they just progress up from a more balanced middle class baseline rather than an unstable impoverished baseline.

  51. Gravatar of Jason Odegaard Jason Odegaard
    16. September 2011 at 11:21

    http://www.bloomberg.com/news/2011-09-16/bernanke-did-very-bad-job-qe2-1-2-won-t-work-stiglitz-says.html

  52. Gravatar of Cameron Cameron
    16. September 2011 at 11:37

    Jason,

    At least he’s no longer calling for the Fed to tighten. It looks like everyone has moved one step towards Sumner.

    That being said, I found this hilarious… in a terrifying way.

    http://www.bloomberg.com/news/2011-09-15/trichet-urges-euro-officials-to-get-ahead-of-curve-in-crisis.html

  53. Gravatar of Jon Jon
    16. September 2011 at 12:01

    Scott just because money illusion exists now does mean that money illusion would exist after adopting a policy that uses it.

    Needless to say you’d need a conspiracy to prevent the news from being explained until the people got it. Why? Because when money illusion exists but there is no deception, there is no cost of ignorance, no reason to know better. Once you start the deception that won’t be true…

    And we’ve already done an experiment along these lines. The result was massive uncontrolled cost push inflation once COLA were built into every contract to guard againt money illusion style manipulations. Our hard won stable price regime has of late lessened COLA provisions, which in turn has given us much stability.

  54. Gravatar of Rafael Rafael
    16. September 2011 at 12:28

    Hey Scott,

    This might be of your interest:

    http://www.econbrowser.com/archives/2011/09/fincon2.gif

    Cheers

  55. Gravatar of Rafael Rafael
    16. September 2011 at 12:30

    “BFCIUS is the Bloomberg’s financial conditions index, which is a composite measure based on money market and bond market spreads and equity prices.”

  56. Gravatar of John John
    16. September 2011 at 12:53

    Here are the inflation numbers for August 2010 to August 2011.

    Consumer Goods +3.8%
    Finished Goods +6.5%
    Intermediate Goods +10.3%
    Crude Goods +18.4%

    It seems the aggregate demand theorists such as Sumner and Krugman are being willfully ignorant about these numbers. Bernanke’s explosion of the monetary base managed to do all it could do by producing higher inflation. Do you know what it means when you’re at the zero lower bound, experiencing rising inflation, and unemployment is still high? Monetary policy and government spending are done. They don’t work at lowering unemployment anymore without an unacceptable inflationary trade off.

    This is fine. There are much more effective and fair ways to end the recession: repeal the income tax, blow up the IRS building, consolidate and eliminate the alphabet soup of government agencies, cut as much as possible out of the Federal Register, legalize victimless crimes, dramatically cut military spending, and abolish the minimum wage. All these measures would increase economic productivity, and spur the type of large-scale job creation that would pull us out of recession while creating a freer society in the process.

  57. Gravatar of grcridlan grcridlan
    16. September 2011 at 12:55

    @KRG

    Can’t say this any clearer: There is no rapidly diminishing consumer power relative to prices.

    Even if the situation you describe pertains across the economy, the money doesn’t disappear. Just because manufacturing workers have less spending power doesn’t change the spending power of the economy as a whole. The only way that the reduced wages savings would disappear is if the company in fact hoarded physical cash. And no company does that. They invest it in short term facilities like bank accounts, where it is then available for others to borrow and spend.

    No matter how many times you add up multiples of (.02 x 1,000,000) and (.8 x 54), the result is always the same. Your argument is losing money on every car, but making it up in volume…

  58. Gravatar of grcridlan grcridlan
    16. September 2011 at 13:01

    @Jon

    NGDP targeting isn’t the Phillips curve. It doesn’t sacrifice the credibility of the central banking authority any more than an inflation targeting regime would do so (has done so).

  59. Gravatar of KRG KRG
    16. September 2011 at 18:47

    ” And no company does that. They invest it in short term facilities like bank accounts, where it is then available for others to borrow and spend.”

    Which is only helpful when people need to borrow money to meed potential consumer demand. If consumers are experiencing an 80% loss of buying power, the only people looking to borrow money are people without income that are desperate for a way to afford food, not businesses looking to produce more products, since, as things stand, they can’t lay off workers fast enough to keep up with the drop. Putting money into a already bloated financial sector only serves to increase the temptation to make bad consumer loans when loans should only really be just available enough to fund people looking to meet a clearly anticipated demand or bridge a predictable revenue cycle.

    Short those, the best we can hope for is that money that gets dumped into finance ends up frozen. But the reality is that it looks for a bubble and blows it up, enriching a very small handful at the expense of everyone else. The only path to real, long term profitability is to ensure that wages are high enough across the board to support self-sustaining consumptive growth, and thus the need for more production. Consumers drive production, on the other hand, no reasonable company will produce more than it expects to be able to sell. Cut consumer power, and the rest of the economy will follow it down the drain

  60. Gravatar of Rien Huizer Rien Huizer
    16. September 2011 at 21:25

    Scott,

    Overall agreement with your post. But “Marxists would argue that further pay cuts for infra-marginal workers would merely raise profits.” Really? Marxists (as well as MBA students) would see this as a crowbar to get more and more cheap workers in until the privileged have become the few. The capitalist will of course pocket the extra “surplus” gained by employing cheaper workers, but his next move might indeed be expansion and hiring more cheap workers (maybe at the cost of less purchasing from suppliers or less automation). And of course in Marx’s world, all capitalist would have to do this in order to survive. What is unique to Marx is that he believed that the capitalists efforts were futile.

    Chrysler is of course a pretty bad case, once insolvent, half-resurrected, merged with Daimler Benz who had no clue but were generous and now in the hands of Fiat, who understand all forms of labor relations, including union leaders who grew up studying Gramsci. The unions know this is the end of the line and thus, the thing we marvel about here is a compromise. I guess the same compromise exists in Turin (expensive legacy workers and cheap ones/casuals) , but maybe you were there yourself, recently..

    I am still puzzled by your reference to Marx though..Traditionally the Marxist position on the sort of unions we see operating here, is that they are “collaborationist” (wrt class struggle). Marxists would see (stripped of jargon) unions as a market response to an opportunity to organise workers after the emergence of large work-complexes (factories etc) in order to let them enjoy the benefits of collective rather than individual bargaining (of course in return for attractive work for union bureaucrats). Marx was a classical economist after all.

  61. Gravatar of Rien Huizer Rien Huizer
    16. September 2011 at 22:00

    Scott

    And if the view that trade unions were a market response to conditions that are increasingly anachronistic , maybe that should make us reconsider the sticky wages thing. The question then is, what replaces the traditional wage setting mechanisms. If unions become obsolete (for instance when healthcare is decoupled from employment, like in countries with public health systems, and there are fiscal incentives for small contractors (payroll tax and social security exemptions like in some Eur countries, Australia, etc). Do wages then become less sticky? When over half the labor force is either casual or a free lance contractor?

    Some of the commenters above ascribe psychjological factors to the phenomenon and that might well be the case in small settings: will the shop owner reduce the shop assistant’s wage in a face to face encounter? Maybe,. maybe not. And if the only changes in labor markets are shifts within a two by two matrix of unionized/non unionized and large scale/small scale employment, what dominates? When the large/unionized becomes less relevant, how are the gains distributed across the small/ununionized and the large/unionionized? And what about the contractors?

    Probably the main ramparts of the sticky wages bastion are now in the hands of gvt: (1) the minimum wage as a (still) out of the money barrier (but could become more relevant as the present recession lingers on and we end up with say 20% of the labor force effectively underemployed), and (2) the public sector and the service industries that effectively operate on a cost plus basis (health care especially). The public sector is an active support and the medium wage a contingent one.

    To what extent can the taxpayer force public sector managers to do what businesses do that employ independent contractors? By firing employees and replacing them with contractors. Is that politically feasible? Probably, increasingly, yes. Would the medium wage hold under severe unemployment pressure? Probably not.

    So maybe with the looming demise of sticky wages what happens to macroeconomics??

  62. Gravatar of Browsing Catharsis – 09.17.11 « Increasing Marginal Utility Browsing Catharsis – 09.17.11 « Increasing Marginal Utility
    17. September 2011 at 04:13

    […] Wages are sticky, we don’t know why, and this doesn’t really have anything to do with Ch…. […]

  63. Gravatar of Scott Sumner Scott Sumner
    17. September 2011 at 07:59

    Morgan, You said;

    “3% level targeted NGDP is far more likely to get conservative support than 5%, right?
    Maybe think through why that is.”

    Perhaps because conservatives don’t understand the superneutrality of money?

    David Pearson, It would be nice if someone did that. My guess is that wages are now above trend.

    James, You said;

    “Money illusion doesn’t really exist”

    Then why are workers far more unwilling to accept nominal wage cuts than real wage cuts? Why the discontinuity at zero in the nominal wage gain distribution, but not the real wage gain distribution?

    John, Sticky wages were already the standard theory of recessions before 1929–for instance the 1921 recession was attributed to sticky wages.

    grcridlan, That may well be right, but you still have the fallacy of composition problem.

    MTD, Good point–more M2 doesn’t mean more NGDP.

    Thanks for the info Martin.

    David, This is supposed to explain cyclical changes. There are also long run changes in the share of national income going to labor that are unrelated to monetary policy and the business cycle.

    Steve, Very good observations about sticky wages.

    flow5, You quoted The Economist:

    “It would also be harder to explain to the public”

    Really? During a severe recession it’s harder to explain to the public that you are trying to boost their incomes, compared to explaining that you are trying to increase their cost of living? I didn’t know that.

    Benjamin, You said;

    “This demonstrates that the Fed isn’t truly targeting inflation in a fashion that would completely offset fiscal policy – they’re ‘quasi-targeting’ it in a downwardly biased way. So as long as fiscal stimulus doesn’t push inflation above 2% it definitely won’t be offset by the Fed.”

    The final sentence of this paragraph doesn’t follow at all from the first sentence. Suppose the Congress had done a bigger fiscal stimulus in early 2009. It’s quite likely that the Fed would not have done QE1 or QE2. So the Fed would have been at least partially offsetting fiscal stimulus, even if inflation never reached 2%. The mistake you Keynesians keep making is to only think in terms of the Fed offsetting fiscal stimulus with some explicit move to raise rates or otherwise tighten policy. But they can also sabotage it by refraining from QE that they would otherwise do.

    I also don’t understand why you oppose a new mandate. You admit Fed policy is failing, so why not change it? There is zero chance of the Congress doing enough fiscal stimulus to have a major impact on the 15 million unemployed.

    Ben and Steve, I think you are right about the psychological reasons for money illusion.

    libfree, Yes, that explanation makes sense.

    Russ, It’s not just Chrysler, we have overwhelming statistical evidence that wages are sticky downward–look at a distribution of nominal wage changes, and see what happens around 0%.

    KRG, I’m assuming that if Chrysler cuts wages national income won’t change, because the Fed won’t let it change. If I’m wrong then there is no hope, we’ll never recover from the recession.

    Lorenzo, Maybe, but because people have money illusion it’s not clear that they even understand the question. Most people have trouble with the concept, as I’ve found in the comment section. I got many explanations about why it might be “rational” but they were all wrong. But I’d agree that that is probably the best we can do.

    William, Matt is wrong, he’s ignoring the super-neutrality of money. Monetary policy was actually pretty good during 1982-2007–so that’s not the explanation for wage stagnation.

    Jason, That’s right.

    MikeDC, If workers were rational they’d care about real wages, not nominal wages. A 1% pay cut with 1% inflation is far better than a 5% pay rise with 9% inflation. But workers act as if it’s worse.

    Jason, Stiglitz is not very good at monetary economics.

    Cameron, Yes, ironic.

    Jon, You said;

    “Scott just because money illusion exists now does mean that money illusion would exist after adopting a policy that uses it.”

    Good point, which is why I’d never recommend a policy that depended on the existence of money illusion. NGDP targeting would work even better if there were no money illusion.

    Rafael, Thanks for the link.

    John, You said;

    “It seems the aggregate demand theorists such as Sumner and Krugman are being willfully ignorant about these numbers.”

    Please don’t lump me in with Krugman. Krugman thinks inflation is important, I pay no attention to inflation. I focus on NGDP growth, which has been slowing down for quite some time, and is far below normal.

    Rien, I defer to your expertise on Marx.

    I strongly disagree with your view on sticky wages. Many commenters talk as if sticky wages are a quaint hypothesis that I am entertaining. No, it’s an empirical fact, that has little to do with unionization. Indeed there is no logical reason why wages should be stickier at union firms than non-union firms, although perhaps the two tier structure is more common at union firms–but that’s a separate issue.

  64. Gravatar of spencer spencer
    17. September 2011 at 08:22

    Sticky wages are just good, basic, classical micro economics.

    When firms lay off employees their is a very strong tendency to lay off the least productive workers. Is that why seniority plays such an important role in layoffs even without unions?

    Consequently the marginal product of the remaining workers is higher.

    So if marginal cost — i.e. — wages is equal to marginal product the wages of the remaining workers should be sticky and/or actually higher.

    Why do academic economist who teach this every year have so much trouble understanding why wages are sticky. Of course it would not
    be their ideological beliefs, would it?

  65. Gravatar of ssumner ssumner
    17. September 2011 at 18:51

    Spencer, You are confusing sticky wages and procyclical productivity. When economists talk about sticky wages they are referring to nominal wages, not real wages.

  66. Gravatar of Rien Huizer Rien Huizer
    18. September 2011 at 00:03

    Scott,

    I did not deny that nominal wages appear to be sticky, have done so for a while and appear to still be doing so in the face of very high unemployment.

    My point was that you raised the question why they (still) are. I would look for explanations in institutional features (large employers vs collective bargaining, minimum wages, and the presence of certain types of employers (state, health care) with weak incentives to bargain hard. And of course the standard micro issues like search costs and mobility. And since you used the two tier phenomenon at Chrysler as a case (where the average compensation is a lot lower, depending on the proportion of cheaper workers in the mix), I added a few examples of relatively new institutional arrangements in countries with previously highly controlled labor markets that achieve the same result (lower average compensation at the expense of the “newcomers” etc) without provoking the the entrenched workers to use union force. Contractors are another device. I do not believe that these changes do not lead to greater labor market fluidity and ultimately, less sticky wages.

    And my question of what happens when we have much less sticky wages. I guess that makes the nominal case a little weaker but we will still have sticky prices. Or not.

  67. Gravatar of Scott Sumner Scott Sumner
    18. September 2011 at 09:10

    Rien, Those factors may play a role, but at a purely theoretical level seem to predict real wage stickiness. To economists there are two mysteries. Why are wages sticky? And why does the stickiness show up in nominal terms and not real terms? Of course in the real world those two problems (institutional factors and money illusion) interact to produce the wage pattern we actually observe.

  68. Gravatar of MikeDC MikeDC
    18. September 2011 at 14:14

    A 1% pay cut with 1% inflation is far better than a 5% pay rise with 9% inflation. But workers act as if it’s worse.

    These examples don’t even begin to represent real world situations though. Outside of lab experiments “Workers” don’t control or even know inflation. They certainly don’t get a meaningful choice between those opportunities. Their nominal wage is all they have much certainty over.

    What’s more, these experiments completely omit savings and future expectations, which seem obviously crucial to making a rational decision.

    Introduce the realistic notions that:
    1. Workers save some of their income.
    2. Can gain an above inflation return on their savings.
    3. Future expectations are stable.

    and a wage increase with inflation is often a rationally better alternative than a wage cut (or freeze) and lower inflation.

    It’s not irrational money illusion, it’s rational expectations about an uncertain future in which money and savings are valuable that leads people to prefer wages.

  69. Gravatar of Morgan Warstler Morgan Warstler
    18. September 2011 at 17:30

    “Then why are workers far more unwilling to accept nominal wage cuts than real wage cuts?”

    Workers do NOT have a choice.

    If the government aids them in not being forced to work for market wages, the problem is not sticky wages, the problem is government.

    We cannot judge it, unless the government is TRYING to unstick wages.

    See Japan wanting to not have inflation.

    This is the winning argument.

    It is OBVIOUS on its face.

    There has been no logical response to it.

    You people need to step it up.

  70. Gravatar of Benjamin Daniels Benjamin Daniels
    18. September 2011 at 21:12

    Scott, you said:

    “The mistake you Keynesians keep making is to only think in terms of the Fed offsetting fiscal stimulus with some explicit move to raise rates or otherwise tighten policy. But they can also sabotage it by refraining from QE that they would otherwise do.”

    I acknowledge this though, so I’m saying: ‘There’s an upper limit to the total amount of (fiscal + monetary) stimulus the Fed will allow, but the Fed itself is not putting us there – and we don’t know whether it will. We also know that the Fed will probably not engage in QE that takes inflation above 2%. Therefore we can boost the economy through fiscal policy rather than waiting for the Fed to act, and we know at about what point they will start offsetting fiscal expansion.’ Is that a bit clearer exposition of my particular Keynesian justification?

    You also said:

    “I also don’t understand why you oppose a new mandate. You admit Fed policy is failing, so why not change it?”

    Because this is a path-dependent policy area. I would prefer a different mandate, but legislating a change in Fed policy destroys the standard of an independent central bank. It’s just a question of which you think is more valuable – policy independence for the future (imagine a motivated hard-money Congress following a mandate-change precedent and severely restricting its powers), or potentially better policy now. I think the odds of a properly-legislated change are low, and the risk of opening the door to worse policy in the future is high.

  71. Gravatar of Morgan Warstler Morgan Warstler
    19. September 2011 at 06:54

    ROFL!

    “imagine a motivated hard-money Congress following a mandate-change precedent and severely restricting its powers”

    ROFL!

    Benjamin, WHY do you think Sumner advocates this plan???

    Dude, trust me, we’re GOING TO ADOPT THUS. but we are going to do it after Rick Perry becomes POTUS, and the target will be 4% or below.

    Scott, won’t do the math out loud, he’ll skip over it, but he’s on record being willing to accept 3%.

    And the really fun stuff happens at 3%.

    Jesus we hit 3% easily, which means HARD MONEY.

    Benjamin what do you think happens to US debt when rates go up automatically whenever the economy grows?

    ROFL! Sumner’s policy puts US gvt. spending in a bag and throw it in the river.

  72. Gravatar of spencer spencer
    19. September 2011 at 09:30

    I still disagree with you.

    The question is not what are short and long term trends.

    The question is why firms do not cut wages and whether it is short run or long run does not matter to the firm making the decision.

    Look at a different way. Assume demand falls from 100 to 90.
    OK, the marginal revenue of the employees producing product from 91 to 100 suddenly becomes zero ( O ) while the product of the employees making products zero to 90 is unchanged. Since there marginal or average revenue is unchanged there is no need to cut there wages. Moreover, since the revenue of the employees that were laid off is zero their wages should also be zero. You can not cut their wages low enough to make them employable as long as demand is still 90.

    this is basic classical micro economics.

  73. Gravatar of Scott Sumner Scott Sumner
    19. September 2011 at 10:22

    MikeDC, I don’t understand your post. What “experiments” are you referring to?

    Benjamin, I still don’t follow your argument. Are you saying that if the government hadn’t done fiscal stimulus in 2009, then 2011 NGDP would be lower than current levels? If so, what sort of monetary policy assumptions would get you that result? i would assume the fed wouldn’t allow much less than 4% NGDP growth over three years (1.4% per year), which is what we’ve actually had. I don’t doubt that you can come up with odd assumptions that make fiscal stimulus work, I just don’t find them very plausible.

    If we don’t change the Fed’s mandate, these problems will keep re-occurring. I’d rather take my chances with a new mandate. The argument you make is identical to the argument people used for not abandoning the gold standard.

    I see very little chance Congress would enact a mandate that led to high inflation– there is overwhelming political opposition to such a policy in the US.

    Spencer, Sorry, but I don’t follow your argument. Are you talking about a nominal or a real demand shock? I am considering a nominal shock.

  74. Gravatar of Benjamin Daniels Benjamin Daniels
    19. September 2011 at 11:34

    “Are you saying that if the government hadn’t done fiscal stimulus in 2009, then 2011 NGDP would be lower than current levels?”

    No. I agree that the gains in NGDP accomplished by the 2009 stimulus were likely offset by an equivalent reduction in scale of the subsequent QE programs.

    But – I would say that at the time, we did not know that the economy was bad enough to warrant more than $800B worth of support, and so had good reason to believe that a stimulus of that size would have entirely averted the need for extraordinary Fed action. At that point the opportunity to legislatively direct the necessary additional spending becomes very attractive as there is so much infrastructure work to be done. Fed easing rarely gets bridges built, so we’re looking at a qualitative difference in outcomes.

    But that’s somewhat besides the point – what I’d really like to clarify is “why do I think more stimulus will increase NGDP now.” Well, the Fed stopped QE2 when inflation ran to around 2% and NGDP around 4%. There’s no reason to expect more monetary stimulus given that the Fed seems content at that level, so there’s no reason to believe that fiscal stimulus which pushed those metrics above those levels would be reducing the scope of future QE. Then we also have the interest-rate commitment, which is a strong signal that there won’t be offsetting *conventional* tightening. So I think we have clear signals that further fiscal stimulus will not be offset like 2009’s (either implicitly or explicitly) was and will actually increase NGDP – if only because the Fed is allowing it, but also because we don’t believe the Fed would do it on their own, *even though I agree they could*.

    (The qualitative argument applies here too, even if things are bad enough that more Fed action occurs and it turns out that further stimulus is offset in the same way – maybe we’d still prefer to engage in extra public-works spending rather than having all the extra output allocated through private channels.)

    Then there’s the question of the Fed mandate:

    “The argument you make is identical to the argument people used for not abandoning the gold standard.”

    I don’t think that’s right. The monetary standard was always expressly under legislative power, and so modifying it was a consistent policy track. But when we decided to create an independent central bank, the whole point was to divorce it from the control of the sitting legislature. I don’t think that’s a decision we can go back on without permanently forfeiting the idea of central bank independence.So we have to ask: is that worth it? And I don’t know the answer, but:

    “I see very little chance Congress would enact a mandate that led to high inflation.” I agree – I’d be much more concerned about overly tight money. So I am very worried that a non-independent central bank would feel a lot of pressure from the hard-money faction during depressionary episodes.

  75. Gravatar of MikeDC MikeDC
    19. September 2011 at 17:03

    Scott,
    The standard experiment for seeing if people suffer from money illusion is to ask them whether they’d prefer a nominal wage increase with higher inflation or a nominal wage cut with lower inflation in the manner of Kahneman and Thaler’s surveys. Right?

    When respondents prefer the nominal wage+inflation hike, it’s cited as evidence for money illusion.

    My point is that if workers save some of their income and have access to above inflation adjusted returns, they shouldn’t be indifferent between the two options. They should prefer a higher nominal wage.

    http://www.cog.brown.edu/courses/cg195/pdf_files/fall07/Kahneman&Tversky1986.pdf

    “The standard experiment” is to say something like: “A company is making a small profit. It is located in a community experiencing a recession with substantial unemployment [but no inflationland inflation of 12%]. The company decides to [decrease wages and salaries 7%lincrease salaries only 5%] this year.”

    In a world where Y=C, then they’re equivalent.

    But in a world where Y=C-S, and we can generate a better than inflation return on S, it’s better to have the nominal wage hike.

    Simple math. I earn $1000 this year and save $100 of it. The other $900 is consumption. I’m offered Kahneman’s choice for next year.

    If I choose a 5% cut + 7% inflation, I earn $950 and spend $963, dipping into my savings. If I’d had the $100 of savings invested in TIPS at a .07% plus inflation, I end the year with $94 in the bank which is about 10% of my annual expenditures.

    If I choose a 5% raise with 12% inflation, I earn $1,050 and consume $1,008, so I can add another $42 to my savings. That $100 of savings invested in TIPS at .07% plus inflation yields $112, so I end the year with $154 in the bank which is about 15% of my annual expenditures.

    IE, the two choices are *NOT* equivalent in real terms and workers are right to prefer the nominal wage increase+inflation option.

  76. Gravatar of MikeDC MikeDC
    20. September 2011 at 06:14

    Sorry, I really screwed up that simple math. However, using Kahneman’s example correctly still bears out my point:

    * If I choose a 7% cut + 0% inflation, I earn $930 and spend $900. If I’d had the $100 of savings invested in TIPS at a .07% plus inflation, I end the year with $130 in the bank which is about 14.5% of my annual expenditures.
    * If I choose a 5% raise with 12% inflation, I earn $1,050 and consume $1,008, so I can add another $42 to my savings. That $100 of savings invested in TIPS at .07% plus inflation yields $112, so I end the year with $154 in the bank which is about 15.3% of my annual expenditures.

  77. Gravatar of ssumner ssumner
    20. September 2011 at 12:27

    Benjamin, You said;

    “There’s no reason to expect more monetary stimulus given that the Fed seems content at that level, so there’s no reason to believe that fiscal stimulus which pushed those metrics above those levels would be reducing the scope of future QE.”

    I wouldn’t be surprised if you are proved wrong within 24 hours.

    You said;

    “I don’t think that’s right. The monetary standard was always expressly under legislative power, and so modifying it was a consistent policy track. But when we decided to create an independent central bank, the whole point was to divorce it from the control of the sitting legislature.”

    That’s precisely the argument that was made in favor of the gold standard. But I’ll grant you this point. It would probably be better if the Fed independently developed a NGDP targeting mandate on their own, after consultation with elite macroeconomists, just as they developed the 2% inflation target on their own in consultation with elite macroeconomists. As compared to Congress getting into this mess.

    MikeDC, You said;

    “The standard experiment for seeing if people suffer from money illusion is to ask them whether they’d prefer a nominal wage increase with higher inflation or a nominal wage cut with lower inflation in the manner of Kahneman and Thaler’s surveys. Right?”

    I haven’t studied that data. What makes money illusion obvious is the huge discontinuity in nominal wage gains at zero percent. In the laws of economics zero percent in nominal terms is a meaningless number. But it the real world it obviously has great meaning.

  78. Gravatar of Benjamin Daniels Benjamin Daniels
    20. September 2011 at 16:22

    “I wouldn’t be surprised if you are proved wrong within 24 hours.”

    If I am, then I would absolutely agree that further fiscal stimulus would be totally offset in NGDP terms, and the only reason for it would be a distributional/political one. But I still think that the weight of conservative voices on the FOMC make it unlikely that they will drive NGDP so high that sufficient fiscal stimulus could not be functional. That’s a question of ‘am I reading the Fed right’ and, well, I can very easily be wrong on that, but that doesn’t spoil the theoretical argument that fiscal stimulus can be effective under a certain set of central bank behaviors.

  79. Gravatar of Benjamin Daniels Benjamin Daniels
    21. September 2011 at 10:38

    So now it looks like the new program will mainly avoid ‘passive tightening’ while driving down long-term nominal interest rates, but I don’t see a strongly stimulative policy here by any stretch. Since its scope is fixed in nominal terms ($400B), crowding out of stimulus is not an issue at all with this program. Also: “The Fed said that “economic growth remains slow” and inflation will settle at or below levels consistent with its dual mandate.” (http://goo.gl/xZjyz)

    So, I think we clearly now have conditions consistent with effective fiscal stimulus, as I have argued. Thoughts?

  80. Gravatar of Collective Conscious » Reaction to Market Monetarism Collective Conscious » Reaction to Market Monetarism
    22. September 2011 at 15:56

    […] a result of a conversation in comments over at TheMoneyIllusion, I thought a lot about what exactly Scott Sumner has been saying all this […]

  81. Gravatar of ssumner ssumner
    26. September 2011 at 11:52

    Benjamin, Well you certainly were’t proved wrong within 24 hours, but that begs the question of what the Fed hoped to achieve, and what they might do next when it’s clear that “Twist” didn’t work.

    I’ve never said fiscal policy definitely doesn’t work, and indeed I favor an employer-side tax cut. But I’m still skeptical of the efficiacy of fiscal stimulus in the current policy environment, because I don’t know what the Fed is up to. But you clearly might be right. I’d stil lsay monetary policy offers far more hope, however. Unfortunately, both now look politically unrealistic.

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