Real wages are very different from real incomes

I get lots of commenters complaining that monetary stimulus would not work because it would lead to inflation, which would reduce real wages.  This would (they claim) lead workers to buy less stuff.  They are confusing real hourly wages with real income.  In standard sticky wage models, monetary stimulus will reduce real wages and boost real income.  I can’t be sure, but I wonder if Steve Waldman might have made a similar error:

A recession, in the New Keynesian telling, occurs when this stabilization policy is not sufficient. If changes in supply and demand are so great that “sticky downward” prices must fall faster than the targeted rise in the price level, markets won’t clear. If the “sticky downward” price is workers’ wages, then it is employment markets that won’t clear, and we will experience mass joblessness. If this occurs, a cure would be to increase the targeted rate of inflation until real wages fall relative to other goods and services. When real wages fall enough, employment markets will clear again and the recession will end.

In the post-Keynesian story, a depression is driven by an decrease in agents’ willingness or ability to carry debt. Agents “pay for” decreased indebtedness by devoting their income to the purchase of safe assets (including especially their own outstanding debt) rather than spending on real goods and services. Unfortunately, money spent on financial asset purchases does not create income (they are asset swaps), and may not be cycled back into income for producers of real goods and services. So, in aggregate the attempt to reduce indebtedness can lead to a reduction of income that sabotages the attempt to pay down debt. This is the famous “paradox of thrift”. We simultaneously experience unemployment (reduced spending and income to real goods and service providers plus sticky wages means that people get canned) and financial distress (reduced income and fixed debt makes prior debt ever more burdensome). In this story, reducing real wages is not a solution. Real wage reductions might mitigate unemployment temporarily, but they also engender financial distress. Financial distress then causes agents to redouble their efforts to satisfy debts, reducing aggregate income and requiring further reductions in real wages ad infinitum. The only way out of a post-Keynesian depression is to increase real wages relative to the real burden of debt. In the post-Keynesian story, inflation is helpful only if real incomes hold steady, or, at very least, fall more slowly than the real value of prior debt.

That criticism of the New Keynesian model seems slightly misleading, as most versions don’t assume wage stickiness is the key, or that real wages will be countercyclical.  But let’s put that issue aside for the moment.  It seems to me that the final sentence is a non-sequitur, or perhaps is confusing wages with incomes.

Keynes argued that wage and price stickiness were factors in the transmission of nominal shocks into real output changes, but also famously argued that wage cuts probably wouldn’t help, because they would simply push you deeper into deflation.  But that argument has no merit if the central bank is targeting inflation or NGDP (as in Britain today.)  In that case wage cuts can increase employment.  Now that doesn’t mean that a fall in real wages will necessarily be correlated with higher employment—we’ve known for decades that there is no reliable cyclical relationship between real wages and the business cycle.  Indeed I’ve argued that we should stop talking about inflation and real wages entirely, and instead focus on the ratio of hourly wages to NGDP.  That ratio rose sharply in the US during 2009, and I’m almost certain the same happened in Britain.

In fact, in every single macro model ever developed (including Austrian, RBC, monetarist, Keynesian, and Marxist) expansionary policy initiatives are only successful if real incomes don’t fall, because real income is the variable you are trying to expand!  Now I suppose some readers are thinking that I’m nitpicking, and that Steve obviously meant real wages, not real incomes, in that final sentence.  But that won’t work either, as it would make the rest of his claim incorrect.  It is real incomes that determine consumption spending, it is real incomes that determine ability to serve debt.  Not real hourly wages.  Even shifting to an income distribution argument won’t help; as long as the central bank targets inflation of NGDP, it’s almost impossible to tell a story of high unemployment and downward flexible wages.

And yet I oppose policies aimed at reducing wages, as they will not work, and will merely provide a distraction from the need for greater NGDP.  So in policy terms I’m right with my “frenemy” Steve Waldman.  I just don’t think the real wage patterns observed in the UK tell us anything about the relative validity of New or Post–Keynesian models.  I do agree with Richard Williamson, however, that this data suggests supply-side problems play a greater role in the British recession than the US recession.  He has a new post showing Krugman looking at the distorting effect of the VAT increase without first accounting for the decrease that occurred slightly earlier.  I’ve been watching the British situation with great interest and Williamson is clearly right and Krugman is clearly wrong.

That’s not to say Britain doesn’t also have major demand-side problems, as Britmouse has ably demonstrated.


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49 Responses to “Real wages are very different from real incomes”

  1. Gravatar of Frederic Mari Frederic Mari
    30. April 2012 at 05:20

    Sorry but is that not nitpicking in a different way? That is, real wages are pretty important to real income. And, if your real wages are stagnating/declining, the fact that, say, government transfers allow you to stay afloat is… nice but not conducive to re-igniting AD.

    For people for whom salaries/wages are a rounding mistakes in their income, the problem is different. They might vary their sumptuary consumption according to what they think might be ‘good taste’/socially allowed but, anyhoo, they are not the drivers of AD.

    Basically, is that not a difference without consequence?

  2. Gravatar of dwb dwb
    30. April 2012 at 05:33

    sounds like you are basically saying people are making the fallacy of composition: individually, some peoples wages might go down, but in aggregate real income goes up.

    By the way, not *everyones* real wages need to go down, I am deeply skeptical that “higher inflation” would result from higher ngdp (or is actually needed or desired).

    when we say things like “depression is driven by an decrease in agents’ willingness or ability to carry debt” and “So, in aggregate the attempt to reduce indebtedness can lead to a reduction of income that sabotages the attempt to pay down debt.” I prefer to real rather than abstract issues here because they are connected:
    1. lets not forget that the decreased willingness/ability to carry debt is primarily due to the reduced value of housing as collateral for mortgages; and
    2. mortgage defaults are driven by the dual trigger of negative equity and unemployment (or otherwise inability to pay). people with negative equity generally pay until they can no longer pay. high unemployment increases the probability they will not be able to pay, and subsequent defaults feed lower collateral values.

  3. Gravatar of Bill Woolsey Bill Woolsey
    30. April 2012 at 06:02

    Scott:

    It seems to me that there are two things in your argument. I think you want to emphasize that the real hourly wage rate (or, for that matter, the real annual salary) could fall, but the number of hours worked or the number of people employed could increase, to aggregate real labor compensation could increase.

    The other element of the argument is that real profits, interest, or rents might rise (in total) so that even if aggregate real labor compensation might fall, real income might rise.

    I imaging that increases in all of the real aggregate income categories is what you expect.

    Anyway, consider the following story. Monetary policy works by increasing borrowing and so spending on output. This results in higher inflation. If the inflation lowers real wages, then this lowers real expenditure. Won’t this make the monetary policy ineffective?

  4. Gravatar of John hall John hall
    30. April 2012 at 06:24

    I think it will help to make your language clearer about these sorts of things. Expressing things in terms of a monetary disequilibrium and a labor market disequilibrium might help. Easier monetary policy will help ameliorate the monetary disequilibrium, but not necessarily a labor market disequilibrium.

  5. Gravatar of D R D R
    30. April 2012 at 06:36

    Most economic models may assume away any importance to households, but the capital and labor shares do matter quite a bit to most households in the real world.

  6. Gravatar of Ritwik Ritwik
    30. April 2012 at 06:47

    Scott

    Would you at least say that a fall in hourly wages/NGDP should increase employment? And vice versa?

  7. Gravatar of Major_Freedom Major_Freedom
    30. April 2012 at 06:58

    There is no such thing as a “demand side problem.” It is an illusion that arises from supply side problems.

    Individuals have a desire for practically infinite real wealth. The desire for more wealth always outstrips the ability to produce more wealth. Ask anyone if they would like more real wealth, as long as the prices are right, and everyone, except perhaps ascetics, will say “yes please!”. So what does “as long as the prices are right?” It means as long as real wealth is produced in the proper relative proportions, that is, in accordance with the law of marginal utility.

    The origin of the myth that there exists demand side problems is the fallacy of believing that what is true for a single company, must be true for the economy as a whole, i.e. the fallacy of composition. While it is the case that at the individual producer level, production depends completely on demand, in the aggregate it is the reverse. Demand depends on production.

    The Fed is so poisonous that it encourages the belief that because a single producer could profitably cover the costs of his investments by receiving a higher nominal demand for his products, then why not in a depression use the magic of inflation to bring about higher aggregate monetary demand, so that businesses in general can profitably cover the costs of their investments! We can avoid unemployment and we can avoid declines in output, all without raising prices too much!

    The error in this thinking is the false belief that whatever current investments are made, whatever tasks employees are currently directed, should somehow remain where they are, in stasis, with no change, no dynamics, and that nominal demand should be increased via inflation to whatever extent is necessary to coax people into spending more money to prevent these resource and labor allocations from becoming “idle” due to recalculation of lower prices.

    What makes me chuckle is considering the fact that when inflationists believe there is a supply shortfall, that is, when inflationists believe prices are rising too much, they don’t advocate that the state engage in “real supply policy”, of increasing the supply of goods and services so that prices come back down. Of course this is trivial because the state doesn’t produce goods or services, but it shows that inflationists are forced by their own worldviews into believing there exists demand side problems.

    The state can’t bring about more supply of goods and services with its power (oh if only they could, huh statists?). But it can print money! So if there is a disjoint between supply and demand in the aggregate, then let’s pretend it is a “demand side problem” (we’ll always do this in practise, and in theory we’ll just give a token shout out to supply side problems, because the only thing we can yammer at the state to do is increase demand). We’ll say that the disjoint between supply and demand in the aggregate can be solved by the state changing the money relation by fiat. It’s all the state can do, so it must be the only possible solution. Use that hammer for every problem.

    Of course, if the state did produce real wealth, and the market produced the money, then there would all of a sudden be statist intellectuals who say that there are supply side problems, and that when the market produces too much money, or too little money, then the state can engage in supply policy of producing or destroying goods and services. After all, if the state is going to do this, then we shouldn’t be dogmatic. We might as well try to minimize the damage the state does by creating awesome gross domestic supply models.

    Oh but will the statists then say that the state should refrain from increasing supply if it leads to falling prices? Or will they call for more and more real wealth, as is natural, and then say that the state should regulate the money producers somehow into producing more money?

    The great error in market monetarism, as well as every other inflation advocating school, is that it is not true that just because the state can increase nominal demand, it doesn’t mean that it is beneficial to the interests of those who are incurring demand shortfalls. Yes, it is very easy to fall into that trap, because after all, what could be better than the state printing money whenever producers in general experience demand shortfalls for their products? The state can force a particular spending increase pattern, and that will guarantee aggregate economic profits. Even if every individual took 100% of their nominal incomes and invested it all, all this investment capital can be profitably covered next year because next year the state will have increased spending by 5%! So if the only spending that takes place this year is investment spending, say in the amount of $10 trillion, then next year, where total spending will be forced as $10.5 trillion (5% increase), aggregate profits will be $500 billion. Aggregate profits are guaranteed.

    If the state can guarantee aggregate economic profits year after year after year, then an economy will never have to go through a correction period brought about by idiotic declines in spending that obviously aren’t necessary! We can have paradise on Earth, or at least a minimized Devil, given that Devils have to exist and print money of course, since we’re not dogmatists.

    This ideology is, to me, akin to ancient tribal superstitions of turning death into life, of stone into bread, of water into wine, of lead into gold. It’s just the most recent incarnation of wanting something for nothing.

    Forcing a 5% increase in spending, contrary to the claims of its supporters, carries with it a seed of destruction, which is the creation of money induced supply side problems. I’ve already gotten a few acolytes on this board to admit that inflation alters relative prices, and this altering of relative prices carries with it real supply side alterations. The crucial point is that these real supply side alterations are physically unsustainable in the real sense. That’s why inflation cannot be used to stop the problems inflation creates.

    Time after time after time, supply side problems that manifest themselves are incorrectly perceived as demand side problems, again because the state can print money so statists are intellectually forced to conclude that the problem is due to an alleged lack of the only solution the state can offer. The state’s only solution is printing and spending money, so the problems in the economy are perceived by market monetarists and other inflationists as a lack of enough printing and spending money. Of course they appear to be right, because look at all those idle resources without adequate demand!

    Not only does theory contradict the demand side problem story, but the empirical data contradicts it as well. This chart shows that during slumps, different sectors are negatively affected differently. Some sectors are far more negatively affected than others.

    If the problem really was an aggregate demand shortfall, then we shouldn’t see this. We shouldn’t persistently see this, and yet we do. This chart shows that the actual problems reside on the supply side, not the demand side. Demand side problems are an illusion, brought about by the fact that supply side problems carry with them reductions in demands. These reductions in demand are incorrectly interpreted by the “hammer for every problem” inflationists as “not enough money printing.” They incorrectly believe that because the state’s solution is printing and spending money, that the drop in demands must be causal, primary, the main driver for supply side problems of output and employment.

    Sumner, you said that Austrian models presume that inflation is successful if it doesn’t lead to a fall in real wages. This is highly misleading. It would be like saying “Austrian models show that as long as Austrians consider themselves to be wrong about inflation, then their models show that inflation can be successful.”

    Austrian models show that inflation affects the real economy in such a way as to make production PHYSICALLY unsustainable. Once the economy is altered in this way, inflation becomes a vain attempt. It is nothing but the state exerting “a” power, that is in fact the cause, primary, the main driver in the very problems you fallaciously interpret as “lack of demand.”

    A person drinks too much and gets drunk. As long as he stays drunk, he doesn’t have to experience the pain of a hangover. Inflationists are saying that the pain he feels whilst getting sober is due to a “lack of aggregate alcohol.” Of course the actual problem is the alcohol consumption, and the pain from the hangover is part of the recovery process. Yes, the state can create more alcohol, yes this can avoid the pain of a hangover, but being constantly drunk is itself destructive, and will eventually kill the person.

    I am saying stop calling for more alcohol, and sternly accept that pain accompanies recovery. The free market is always, ALWAYS attempting (in the descriptive sense, not the purposeful sense) to fix the resource and labor allocation errors prevailing in the economy. As soon as the state stops sending the alcohol, the market soon starts to feel sick because it is in recovery. Market monetarists want the market to be permanently drunk. After all, they were raised in schools financed by alcohol distributors. Their intellectual investment depends on the flow of alcohol remaining intact. They just want to be in intellectual control of the alcohol lever. “No no no, you silly monetarists, we have to keep people drunk at MY rate, not your rate. Your rate is more destructive. My rate is minimally destructive. What’s that? People are saying turn off the alcohol? Hahahaha, dogmatists.”

  8. Gravatar of Ryan Ryan
    30. April 2012 at 07:28

    It’s been said that extremely adverse environmental conditions cause species to evolve. So, when ice ages hit, suddenly all kinds of genetic mutations pop up and we end up with elephants that have fur and stuff.

    But, who in their right mind would argue for elephant refrigeration as a method for increasing the population?

    When people’s money loses value, they figure out how to satisfy their wants subject to those conditions. But devaluing money on purpose in order to inspire people to claw themselves out of a Fed-imposed adverse circumstance ranks right up there with refrigerating elephants.

  9. Gravatar of D.Gibson D.Gibson
    30. April 2012 at 07:31

    Major, That is a lot of words! I like more wealth, because it lets me buy more things. One thing I like to “buy” is financial security. How I buy that depends on expected inflation and the growth rate of the economy. When both are low, security comes in the form of cash. When both are high, security comes from business investment. So, in the aggregate, inflation is good and deflation is bad.

    A question about sticky wages. Are wages equally sticky in both directions? I suspect they are more stick going down than up and that asymmetry matters in setting policy somehow.

  10. Gravatar of Benjamin Cole Benjamin Cole
    30. April 2012 at 07:55

    As Uneasy Money has pointed out, it is wondrous the people who suddenly develop an acute solidarity with the working class, when they complain inflation will cut wages.

    Look, no macroeconomic option is perfect, just as no foreign policy is perfect, no tax policy is perfect.

    The best option is Market Monetarism—as Scott Sumner tirelessly explains every week, and in doing so exhibits a consistent set of ideas.

    Milton Friedman was the same way. You knew how MF would respond to a question, as he thought consistently. For example, MF did not ignore pollution (and call for abolishing the EPA) but called for taxing pollution.

    Scott Sumner is the same way. And I have yet to find a sound argument against Market Monetarism, given current context—except that maybe we should print boatloads of money immediately, instead of trying to finesse this recession.

  11. Gravatar of Saturos Saturos
    30. April 2012 at 08:11

    Bill Woolsey, You said:

    “Anyway, consider the following story. Monetary policy works by increasing borrowing and so spending on output. This results in higher inflation. If the inflation lowers real wages, then this lowers real expenditure. Won’t this make the monetary policy ineffective?”

    I think the fallacy there is that wages aren’t the entirety of nominal income. Nominal spending becomes nominal income, but not only through labor compensation. It’s the same fallacy as over here:
    http://worthwhile.typepad.com/worthwhile_canadian_initi/2011/12/the-gizmo-theory-of-the-recession.html

  12. Gravatar of dwb dwb
    30. April 2012 at 08:17

    @D. Gibson

    Are wages equally sticky in both directions? I suspect they are more stick going down than up and that asymmetry matters in setting policy somehow.

    see below

    http://www.frbsf.org/publications/economics/letter/2012/el2012-10.html

    I’ve already gotten a few acolytes on this board to admit that inflation alters relative prices

    its possible to agree with the statement that inflation alters relative prices and disgree with almost all of the other selfcontradictory bs. deflation is equally if not more caustic to relative prices because wages are downwardly rigid and nominal debt contracts are very sticky.

  13. Gravatar of Saturos Saturos
    30. April 2012 at 08:21

    You should just think of the price level as a whole moving down. When nominal spending can’t buy all the output at the current price level, the price level has to fall to restore equilibrium. And wages have to fall before prices can, otherwise you’d be making losses. In disequilibrium real output and income shrinks (the abscissa is too far left), whereas in equilibrium after the price level falls real output and equilibrium return to potential.

    And if the price level can’t fall then you need to boost nominal spending = NGDP.

  14. Gravatar of Steve Steve
    30. April 2012 at 08:24

    Well, it’s very easy to identify one of the UK’s supply-side problems:

    http://www.reuters.com/article/2012/03/29/uk-oil-idUSL6E8ET53920120329

    UPDATE 1-UK oil output in 2011 falls to lowest since 1970s

    Thu Mar 29, 2012 8:42am EDT
    * Output falls in 2011 to average 1.04 million bpd
    * Oil output drop continues trend in place since 2000
    * Natural gas output in 2011 drops 20.8 percent
    * UK government seeking boost to North Sea investment (Adds details)

    By Alex Lawler

    LONDON, March 29 (Reuters) – UK oil production fell more than 17 percent to average 1.04 million barrels per day (bpd) in 2011, government figures released on Thursday showed, underlining the difficulty in slowing down a decade-long fall in output.

  15. Gravatar of Saturos Saturos
    30. April 2012 at 08:28

    A correction in the price level would imply a temporary fall in wages relative to prices. But at the lower real wages employment returns, output rises and the level of output prices falls down to match wages. And this is assuming that the low level of NGDP remains constant.

  16. Gravatar of Steve Steve
    30. April 2012 at 08:29

    A steady fall in the production of oil and a steady rise in the production of financial gimmickry is a big supply-side problem for the UK. I’m sure there are others, but this one is obvious if you look at the data.

    People miss the real problems sometimes because they are focused on overly aggregated data like inflation, top MTRs, and government spending. Many economists reflexively play tug-of-war with the ‘size of government’ dial, because, well, many economists are political ideologues at heart.

  17. Gravatar of Saturos Saturos
    30. April 2012 at 08:43

    By the way, has everyone seen this:
    http://www.youtube.com/watch?feature=player_embedded&v=vAFQIciWsF4

    Very good sentences:

    “I’m Barack Obama, and I too want to slow-jam the news.

  18. Gravatar of Steve Steve
    30. April 2012 at 08:46

    The UK needs to increase supply of things that despotic international business moguls want, like ginormous high st flats, political asylum, and Oxford educations for their children.

  19. Gravatar of Edward Edward
    30. April 2012 at 09:02

    Major:

    Why are other sectors of the economy affected at all? Your chart doesn’t explain that. If the misiean rothbardian story were literally true, than there shouldn’t have been any downturn AT ALL in other sector. We would have seen retail shortages, manufacturing, durable and non-durable goods shortages. during the boom, and these sectors should have EXPANDED during the bust. (If the Austrian theory is true, and the shortage of cash money doesn’t matter).

    Why should cash holders get a risk free return at the expense of non cash savers? they are already benefiting from the increased liquidity, they get when they act more responsibly. I dont think most MMs on this board disapprove even of cash hoarding. Rather we not its costs on the rest of society. If i want to save cash I should be allowed to do so, the government shouldn’t be able to forbid me from doing it.

    Theft of purchasing power:

    Purchasing Power cant be stolen by inflation because goods and services exist outside of the nominal dollars that I hold.

    Cantillion Effects.

    A solvable problem. Yes tremendously unfair that some should get new money first. But as Sumner noted its not who gets it first its who spends it first. people on fixed incomes can invest in gold and silver and platinum and expand their nominal incomes beyond the fall in its purchasing power.
    Besides, the Fed and the Treasury can write checks w/out open market operations to everyone, helicopter money, and get around C.E. The economy would still expand via the real balance effect.

    The “capital structure”

    The idea that more lengthy production processes are um, more productive is INSANE. On the other hand putting a given production process or capital good X into play for longer periods of time can yes, produce more goods.

    Let me explain.

    Suppose you have a widget factory that has a choice between two widget making machines. The first one makes one widget per hour in an eight hour workday. the second makes five per hour. All other things being equal any sane or rational entrepreneur would choose the second. if “roundaboutness” means that the widget maker will choose the first one over the second. Than its a crazy stupid, insane concept. because that would mean that entrepreneurs would purposefully choose lower quality capital goods to produce their wares slower, and less of them, to satisfy some weird Austrian fetish.

    If roundaboutness means on the other hand that running both machines longer than eight hours will produce more widgets, than its definitely true., but a weak economic law, because the willingness of a entrepreneur to run machines that long depends on perceived demand. All things being equal consumer wants stuff earlier rather than later. So yes working capital goods longer hours can produce more, but isn’t consumer demand the ultimate determinant?

    What does any of this have to do with monetary inflation? Doesn’t it depend more or the technological capability entrepreneurs in general than what the government prints? Even if the government does print money and lends it to entrepreneurs via FRB isn’t it a GOOD THING insofar at it allows them to buy better quality capital goods that are more productive not less?

  20. Gravatar of Ryan Ryan
    30. April 2012 at 09:28

    Edward, I’ll let MF respond to your first point because it looks like he’s on a roll. I’ll also let him respond to your second point about Cantillon Effects because you haven’t really contradicted him, you just don’t see them as being particularly important.

    But as to your third point about production length, you’re misinterpreting the Misesian theory here. In Mises’ world, “processes of production” stack on top of each other. Think of it this way: You can turn soil using a shovel, or you can turn soil using a tractor. But if you want to use a tractor, you have to first *produce a tractor* before you can use it to turn soil.

    In that sense, tractor-assisted agriculture is a process of production that requires more “time,” because it involves the time required to produce tractors PLUS the time required to turn soil. More to the point, it requires *a period of foregone consumption* during which farmers accumulate savings with which to buy tractors.

    That’s what MF and Mises mean.

  21. Gravatar of Edward Edward
    30. April 2012 at 09:44

    “In that sense, tractor-assisted agriculture is a process of production that requires more “time,” because it involves the time required to produce tractors PLUS the time required to turn soil.”

    I wouldn’t say it involves a extraordinary LENGTH of time, IF the tech know how to build a tractor is out there. i can see the Austrian point VERY well when it comes to creating a BRAND NEW invention or capital good like an atomic replicator from Star trek TNG or something. As to your first point the farmer can save, or he can borrow the money, which relies other peoples savings, or FRB. If he borrows from an FRB bank, and buys a tractor, wouldn’t that be, if not a free lunch, a high value meal?

  22. Gravatar of Ryan Ryan
    30. April 2012 at 10:04

    Edward, yes, Mises was referring to “BRAND NEW” inventions. Like I said, production time gets “stacked” in the Austrian tradition. Every time you use a tractor, you are making use of capital that required an initial investment by somebody, somewhere, at some point in time.

    Understanding this is crucial to comprehending Austrian capital theories. When the Fed creates additional inflation, one of the unfortunate side-effects is a disincentive to save i.e. accumulate capital. If we don’t accumulate more capital, then we are confined to the production processes that currently exist. In other words, no one “invents anything new,” be it a new machine or a new process or a new idea or whatever else.

  23. Gravatar of Major_Freedom Major_Freedom
    30. April 2012 at 10:06

    Edward:

    Why are other sectors of the economy affected at all?

    I don’t understand the meaning of this question. I showed a chart of 5 different sectors.

    Your chart doesn’t explain that. If the misiean rothbardian story were literally true, than there shouldn’t have been any downturn AT ALL in other sector.

    What other sectors?

    And the notion that the credit circulation theory of the business cycle shouldn’t have “other sectors” experiencing a downturn is not correct. Production takes time. It takes time for raw materials to be transformed into finished consumer goods. Thus, if there is a larger slump in the higher order stages, then it would be impossible for consumer goods production to immediately increase like an on-off switch. If there is a slump in the sectors that consumer goods production depends on, then of course there will be a slump in “other sectors” as well.

    We would have seen retail shortages, manufacturing, durable and non-durable goods shortages. during the boom, and these sectors should have EXPANDED during the bust. (If the Austrian theory is true, and the shortage of cash money doesn’t matter).

    But that’s exactly what we do see. We do see shortages, which is why the bust arrives at all. These shortages are observed as “credit crunches”, as well as “too high costs” for various investments and “too low prices” for various outputs.

    Investors find that in order to complete their projects, they need more resources than they thought were available, which requires investors to increase their bidding prices for scarce factors to unprofitable levels, which we observe as “lack of demand” to buy them.

    Why should cash holders get a risk free return at the expense of non cash savers?

    Why shouldn’t they?

    Why should government debt holders get a risk free return at the expense of non-debt owning taxpayers, which results from NGDP targeting, and all other inflation programs that consist of buying government debt?

    they are already benefiting from the increased liquidity, they get when they act more responsibly.

    Why should people who earned money by being productive in the past, NOT earn a real return with their cash savings? Why should they only get a “risk free” return if they give their cash to baby killers and torturers who promise to take money from others by force of law?

    I dont think most MMs on this board disapprove even of cash hoarding. Rather we not its costs on the rest of society.

    Society doesn’t incur any costs. Only individuals do. You’re talking mysticism, not science. One person holding cash doesn’t incur any costs on others, because it’s their property. There are no more costs on others through cash holding as there are costs on others from you holding real goods.

    Money is not the property of society. Money is the property of individuals. Individuals owning their own property is not a cost on others.

    Your view of money is tribalistic. You believe “society” owns all money, and that should any individual exercise their own control over their own property in a way that “denies” this money to “society”, that these individuals are somehow incurring costs to this “society.” Hence they must be punished by the state printing money and reducing their purchasing power.

    If i want to save cash I should be allowed to do so, the government shouldn’t be able to forbid me from doing it.

    Uh….

    Theft of purchasing power:

    Purchasing Power cant be stolen by inflation because goods and services exist outside of the nominal dollars that I hold.

    Purchasing power APPLIES to dollars, the very dollars you are holding. Of COURSE dollars and real goods are separate from each other, or what you call “exist outside of the nominal dollars that I hold.” Nominal dollars? As opposed to what, real dollars?

    Purchasing power can indeed by taken, by the state using force of law to demand taxes in dollars, which coerces people into having to accept dollars, and then the state prints those same dollars for itself and those they want to bribe votes and future cash/jobs from.

    It would be like Apple using force to get everyone into giving Apple a quantity of Apple stock, which of course coerces people into having to acquire Apple stock with which to pay Apple, and then Apple issues new stock but only gives it to its inner circle of corporate execs. This will reduce the value of all the other stockholders.

    In other words, if Apple did what the state does, they’d be considered criminals.

    Cantillion Effects.

    A solvable problem. Yes tremendously unfair that some should get new money first. But as Sumner noted its not who gets it first its who spends it first.

    They are one in the same people. Spending money includes any and all exchanging away of money from an owner of money, to another party, through either direct gift giving, or indirect gift giving by necessarily overpaying for goods/securities that would have otherwise had lower prices had no inflation taken place.

    people on fixed incomes can invest in gold and silver and platinum and expand their nominal incomes beyond the fall in its purchasing power.

    Sure, but both gold and silver “gains”, i.e. depreciated dollar, are taxed in dollars, and so people still have to acquire dollars, which means they have to acquire it from people who have already initially received it.

    Investing in gold also has the problem of the state constantly seeking to suppress its price, by raising margin requirements, by lying about how much gold the state has, and other gimmicks (which are of course temporary, but can be long lasting).

    Besides, the Fed and the Treasury can write checks w/out open market operations to everyone, helicopter money, and get around C.E. The economy would still expand via the real balance effect.

    They can, but they don’t, because that would defeat the whole purpose of central banking in the first place.

    You’re talking about a fairy tale land, not the real world.

    The “capital structure”

    The idea that more lengthy production processes are um, more productive is INSANE.

    No, its quite sane. The more time that people have to produce, the more they can produce. Labor is scarce. It’s inherent in economic law. Calling this insane is…insane.

    On the other hand putting a given production process or capital good X into play for longer periods of time can yes, produce more goods.

    That’s what it means!

    Let me explain.

    Oh brother.

    Suppose you have a widget factory that has a choice between two widget making machines. The first one makes one widget per hour in an eight hour workday. the second makes five per hour. All other things being equal any sane or rational entrepreneur would choose the second. if “roundaboutness” means that the widget maker will choose the first one over the second. Than its a crazy stupid, insane concept. because that would mean that entrepreneurs would purposefully choose lower quality capital goods to produce their wares slower, and less of them, to satisfy some weird Austrian fetish.

    No, that’s not what more roundaboutness means. It does not mean a lower quality machine that takes longer to produce the same output. It means more stages in production in the division of labor. It’s an economic concept, not a single machine, single firm concept.

    An example of more roundaboutness in your example would be the introduction of a new stage of production along with these machines. For example, there could be an additional mine that produces brand new machines that increase the productivity of the resources that go into the semi-finished materials that go into the production of the trucks that deliver the machines in question. More of these new mines means more resources that go into the semi-finished materials, which means more production of trucks, which means more machines, which means more production of widgets.

    That’s a lengthening of the structure of production, and in this example that means more time was added by the addition of the mine. All the subsequent stages have to wait for the new mine before they can do what they do.

    If roundaboutness means on the other hand that running both machines longer than eight hours will produce more widgets, than its definitely true., but a weak economic law, because the willingness of a entrepreneur to run machines that long depends on perceived demand. All things being equal consumer wants stuff earlier rather than later.

    Yeah it doesn’t mean that either.

    Question: Have you read anything about the concept of roundaboutness of production? Or are you just flying by the seat of your pants? The literature is available, I suggest you read it.

    So yes working capital goods longer hours can produce more, but isn’t consumer demand the ultimate determinant?

    Ultimately, yes, but that doesn’t mean that consumer demand has to rise in nominal terms before the production of working capital goods can increase. This is because the prices of capital goods can fall as more capital goods are produced, and that decreases the costs of producing and hence prices of consumer goods, which means the same consumer demand can keep buying more and more consumer goods as more capital comes into fruition.

    You have to be careful in not assuming constant prices of capital goods when more capital goods are produced. Keynes made that error in the GT. So many economists today still make that mistake. It’s a highly destructive error.

    What does any of this have to do with monetary inflation?

    It has to do with the fact that inflation into the loan market can lengthen the structure of production even though consumers have not saved enough to warrant this move.

    Doesn’t it depend more or the technological capability entrepreneurs in general than what the government prints?

    Entrepreneurs cannot guess at what the true rate of saving is when the monetary system that otherwise would have communicated it, is altered by monetary policy. It would be like expecting radio listeners to understand everything that is said, in the presence of signal interference.

    Even if the government does print money and lends it to entrepreneurs via FRB isn’t it a GOOD THING insofar at it allows them to buy better quality capital goods that are more productive not less?

    No, because not all projects started are good projects. Not all investment ideas should be put into action. The free market filters out bad investment ideas over time. It minimizes waste. Printing money and FRB brings about investments that are not economical in the context of the overall division of labor, in the real sense, but investors are misled into investing in them anyway because of the monetary policy.

    Who would argue that all the millions of houses that were built during the housing boom, a large portion of which are now empty, was an efficient allocation of scarce resources?

    Of course one could always twist things and say that given the houses were built, some houses are better than no houses, and sure, that is true, but the art of economics can guide us in asking whether or not those houses should have been built at all, and whether or not something else should have been built with those resources, something more highly valued relative to all other things that could have been built.

    This question only the market process can answer, but inflation distorts this process.

  24. Gravatar of Major_Freedom Major_Freedom
    30. April 2012 at 10:23

    Edward:

    I wouldn’t say it involves a extraordinary LENGTH of time, IF the tech know how to build a tractor is out there. i can see the Austrian point VERY well when it comes to creating a BRAND NEW invention or capital good like an atomic replicator from Star trek TNG or something. As to your first point the farmer can save, or he can borrow the money, which relies other peoples savings, or FRB. If he borrows from an FRB bank, and buys a tractor, wouldn’t that be, if not a free lunch, a high value meal?

    The Austrian theory of business cycles cannot be shown through the activity of just one person. Because the economy is complex, and errors take time to be revealed, a single person might get away with completing his projects and getting out of the market in time.

    If we instead consider millions of investors borrowing from FRB banks, and then engaging in some investment activity that redirects resources to them, and away from other possible deployments, then if you abstract away from money for a moment and just consider the real resources being moved around, you have to ask yourself if the new projects are sustainable in the real sense.

    The Austrian theory says no. It says no because consumers have not abstained from consuming to justify the additional investment. The economy gets stretched from both ends, as it were. Consumers are busy consuming what they are consuming, thus tying up resources and labor in consumer goods, when the new investments that are started, require more resources than are actually available. It typically takes a while for investors to realize this, because the world’s economy is so incredibly complex, but investors will realize it sooner or later. Once they do realize it, they experience this lack of real resources as “too high money costs” and “too little nominal demand”.

    Then, as is oh so typical, Keynesians and Monetarists ignorantly believe that the problem isn’t one of a supply issue, but a “lack of demand” issue. They believe that the driving problem is the lack of demand, when in reality it is an EFFECT of the supply side problems. It would be like trying to help people falling over cliffs by believing that the problem is the ground being hit, so the proposed solution is deepening the chasm, whilst ignoring the falling over the cliff part.

    If we instead stop the errors being made, we can avoid any perceived problem of “lack of demand.” You know one of the major reasons how I know Monetarists and Keynesians are wrong? They have no explanation for why demand would fall in the first place. Yes yes, they say it’s because the Fed isn’t printing enough money, but they can’t explain why millions of people across the economy would choose to stop spending as much as they did before on their own volition, despite the fact that the Fed never stopped printing. Monetarists are compelled to fall into the Keynesian trap of “animal spirits”, which of course means “I have no clue why it happens, it just does, so there. I will reason from ignorance going forward.”

    Then they wonder why the economy doesn’t permanently heal, and why it slips right back into recession soon after.

  25. Gravatar of Mark A. Sadowski Mark A. Sadowski
    30. April 2012 at 11:09

    Inflationary illusions – Macro Matters

    Richard Williamson:
    “I think there has been a lot missing from the discussion of the UK in the blogosphere. We are a bit of a puzzle on a purely AD-based explanation of the recession.

    We didn’t have deflation (on annual basis at least), and even stripping out the effect of the VAT rise in 2011 should still show persistent inflation over 3% since 2010 http://www.tradingeconomics.com/united-kingdom/inflation-cpi

    UK inflation expectations seem to be significantly higher here (if falling away a little recently)…I’m not really sure what is going on… If we were to just look at inflation (at expectations thereof), the country that ought to be having an AD-driven double-dip recession would appear to be the US…
    I am becoming steadily less convinced that [an aggregate demand deficiency] is the whole story, at least for the UK.”

    What we really need to do is to strip out not only the effects of indirect taxes (the VAT) but volatile components such as energy and food. Unfortunately while the E.U. nations all do both they don’t do both at the same time.

    One can however subtract the difference between headline and core inflation from inflation minus the effect of indirect taxes. Obviously this is not perfect but it is a reasonable approximation.

    If one does that what one finds is that year on year core inflation in the UK ranged between 0.5% and 1.8% in 2010 and 2011. One will also find that for only 6 months out of 24 did the U.K. rate exceed the yoy core PCE in the U.S.

    The only possible evidence I can find of the U.K. suffering any kind of AS shock since the financial crisis is in 2009 when the year on year inflation rate stripped of indirect taxes, energy and food ranged between 1.7% and 2.8%, and consistently exceeded the U.S. rate.

    But I don’t think that this is difficult to explain.

    Remember that the pound underwent a substantial depreciation with respect to the euro from July 2008 through March 2009 and that imports are egual to about one third of the U.K.’s GDP. Remember also that the eurozone is the U.K.’s largest trading partner. And lest one thinks that striping out energy and food might have already accounted for this, recall that only about a sixth of that the U.K. imports is food or energy, with the vast majority being capital and other manufactured goods.

    There may have been a unique depreciation induced AS shock in 2009 but that was over two years ago. I suggest people look to the annual rate of NGDP growth of 0.8% in the first quarter as a possible culprit. It sounds precisely like enourmously inadequate AD to me.

  26. Gravatar of Richard Williamson Richard Williamson
    30. April 2012 at 11:58

    Mark,

    THe UK does publish CPI exc. indirect taxes, which show inflation running at 4% y-o-y as of March 2009, before falling to about 3% by the end of the year. As for exports, the UK’s terms of trade remained remarkably steady throughout the depreciation and our trade balance (X-M) actually improved during the later months of 2008 and early 2009 (http://www.tradingeconomics.com/united-kingdom/balance-of-trade). I’m not the only one who is stumped , Simon Wren-Lewis is too http://mainlymacro.blogspot.co.uk/2012/03/strange-case-of-disappearing-productive.html

  27. Gravatar of W. Peden W. Peden
    30. April 2012 at 11:58

    “UK government seeking boost to North Sea investment”

    I seem to remember that they introduced a windfall profits tax in the 2011 budget.

    “You’re earning too much! We’re going to take some of your earnings! … Wait, why haven’t you been investing? We’re going to have to introduce a plan for investment!”

  28. Gravatar of Benjamin Cole Benjamin Cole
    30. April 2012 at 13:23

    Major F-

    When people use $100 bills for toilet paper, then maybe I will agree we have printed too much money. I have not seen that yet. Even in Beverly Hills.

    I did see a guy throw down a Ben Franklin for a tip once in Beverly Hills, but he did it as a form of ostentatious consumption—thus proving we have not printed enough money yet.

  29. Gravatar of Mark A. Sadowski Mark A. Sadowski
    30. April 2012 at 14:06

    Richard,
    “THe UK does publish CPI exc. indirect taxes, which show inflation running at 4% y-o-y as of March 2009, before falling to about 3% by the end of the year.”

    Of course, as do all the E.U. members. But the point is that none of them (to my knowledge) publish *core* CPI excluding indirect taxes. You would think that countries with a VAT practicing inflation targeting would publish such numbers but oddly they do not.

    According to my crude but reasonable estimate when one factors out indirect taxes, energy, and food (and alcohol) the yoy inflation rate for the U.K. falls to the 0.5%-1.8% range throughout 2010 and 2011, hardly something to get alarmed by.

    I’m also, aware that Simon Wren-Lewis is stumped. He shouldn’t be. There is no mystery that really needs to be solved (except why the U.K. and other E.U. members don’t publish more useful measures of inflation inertia).

    As for 2009 and the terms of trade issue I’m still exploring it. I find it difficult to believe that the U.K., as dependent on imported capital and other manufactured goods as it is could depreciate its currency to such an extent and experience no effect on its terms of trade at all. Something is very fishy about that result.

    P.S. The balance of trade isnot a very useful way of judging the terms of trade, especially in the short run.

  30. Gravatar of Richard Williamson Richard Williamson
    30. April 2012 at 14:18

    Mark,

    Very good points all round. Thanks. I will probably have to write a self-smackdown post soon. I just realised I forgot to put the link to the BoE paper on the terms of trade, which commented on how stable it was

    http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/qb090402.pdf

    Thanks
    Richard

  31. Gravatar of Britmouse Britmouse
    30. April 2012 at 16:33

    A brief defence of the UK supply side performance here:

    http://uneconomical.wordpress.com/2012/05/01/its-really-the-demand/

  32. Gravatar of Major_Freedom Major_Freedom
    30. April 2012 at 18:18

    Benjamin Cole:

    When people use $100 bills for toilet paper, then maybe I will agree we have printed too much money. I have not seen that yet. Even in Beverly Hills.

    Isn’t that when it’s too late?

    Why not when the fed has to buy 61% of all debt issued from the Treasury in one year?

    Why not when there are malinvestments in housing from way too much credit money?

    Why not when there is almost 1 to 1 correlation between the fed’s balance sheet and the equity market?

    I did see a guy throw down a Ben Franklin for a tip once in Beverly Hills, but he did it as a form of ostentatious consumption—thus proving we have not printed enough money yet.

    Maybe we should only stop nuclear proliferation when there is a nuclear war. I mean prior to that, it’s all just fear mongering, right?

  33. Gravatar of ssumner ssumner
    30. April 2012 at 18:35

    Frederic, I’m afraid you completely missed the point of the post, and are putting words in my mouth. This argument has nothing to do with income distribution.

    Let me explain it this way. If your wage is $17hour, then your income is not $17/year. Do you agree? Income and wages are very very different.

    dwb, It’s worse than the fallacy of composition, I’m not even saying peoples income would fall at the individual level, just the hourly level. Everyone from autoworkers to construction workers would be getting way more hours.

    It’s like the fallacy of composition cubed.

    Bill, You said;

    “If the inflation lowers real wages, then this lowers real expenditure. Won’t this make the monetary policy ineffective?”

    No! Consumption depends on real income, not real wages. There’s a huge difference between $17 and $34,0000. It’s crazy to equate hourly wages with annual incomes.

    Indeed there’s nothing contrarian in my post. The standard sticky wage business cycle models predicts that real wages and real incomes will be inversely correlated. I’m just pointing out that Steve Waldman seems to have misunderstood the standard NK model’s implication. He seems to assume they are positively correlated.

    John Hall, But I’m also arguing it would help eliminate labor market equilibrium.

    DR, Of course it matters to people, but I never said or implied otherwise.

    Ritwik, Yes, that’s exactly what I’ve been arguing. If there are no supply shocks then W/NGDP is highly (and inversely) correlated with output.

    Ryan, You lost me there.

    D. Gibson. Probably more sticky downward, at least near 0%.

    Ben, That’s a good observation by David Glasner.

    Saturos, It’s much more than wages not being all of income, hourly wages aren’t even all of total wages. The two can and often do go in opposite direction. In 2009 real hourly wages rose sharply, but total wage income fell.

    Love the Slow Jam. I’m trying to imagine Mitt Romney . . . nah.

    Steve, Good observation. That helps explain why British jobs haven’t fallen as much as GDP would predict.

    Mark, I’m not sure where you are getting those numbers from. Let’s take the period since mid-2008. There’s been no change in the VAT (it went down then back up.) And not much change in energy prices–a slight fall. And yet the inflation rate since mid-2008 has been significantly higher than the US, and RGDP growth lower. How’s that not an AS problem?

    Richard, Thanks for commenting over here. I agree, as I indicated in my reply to Mark.

    Mark, Suppose inflation is really low. Then that means RGDP growth is quite high. Or do you think NGDP is wrong? British NGDP tracks US NGDP quite closely. So either there are supply side problems, or the recession is no worse than in America, (contrary to Krugman, et al.) But then why is US unemployment falling fairly fast, and UK unemployment rising?

    Britmouse, I agree that you have a big demand shortfall (as do we) but how do you respond to my reply to Mark?

  34. Gravatar of Major_Freedom Major_Freedom
    30. April 2012 at 19:02

    ssumner:

    In standard sticky wage models, monetary stimulus will reduce real wages and boost real income.

    In standard real world free market models, wages are not sticky.

    Not all real income is good real income. A house that is currently being built by a builder who believes he has 50,000 bricks when he only has 40,000 bricks, would not be engaging in “good” real output and would not be boosting “good” real incomes.

    All monetary stimulus does is fool the builder into believing he still has 50,000 bricks, so that he doesn’t lay off any workers and doesn’t cease utilizing complimentary factors of production, all so that the ignorant welfare program data collectors (not economists) can claim “output and employment are growing again!”, thus placating a fooled public, and tax hungry politicians.

    Keynes argued that wage and price stickiness were factors in the transmission of nominal shocks into real output changes, but also famously argued that wage cuts probably wouldn’t help, because they would simply push you deeper into deflation. But that argument has no merit if the central bank is targeting inflation or NGDP (as in Britain today.) In that case wage cuts can increase employment.

    No central bank inflation is needed to counteract this fallacious claim from Keynes.

    Keynes failed to comprehend not only that a fall in wage rates does NOT mean a fall in wage payments (it almost always leads the reverse as investments that were previously postponed, are made again, thus boosting total wages even though each worker is earning less per hour), but a fall in wage rates also leads to a dollar for dollar unit cost of production, including asset prices such as capital goods, which of course labor is a cost component.

    So when costs fall, due to the wage cuts, then any drop in spending that results, is matched dollar for dollar with falling costs. After all, wages are expensed almost immediately.

    The wage price spiral doctrine is a myth built on the fallacy that wages are somehow only a source of demand, but not an equivalent business cost.

    To make it simple for the simple minded, it would be like believing that if a store paid its workers more money, that they can buy more of the store’s goods, and then claiming everyone is better off, and, in the mirror image, it is like believing that if that same store paid its workers less, that the workers can buy fewer of the store’s goods, and then claiming that everyone is worse off.

  35. Gravatar of Major_Freedom Major_Freedom
    30. April 2012 at 19:04

    ssumner:

    dwb, It’s worse than the fallacy of composition, I’m not even saying peoples income would fall at the individual level, just the hourly level. Everyone from autoworkers to construction workers would be getting way more hours.

    Since most of the new money enters the economy as debt, as credit from the banking system, it means what you’re asking for is to increase the debt level in order to raise worker’s wages.

  36. Gravatar of Mark A. Sadowski Mark A. Sadowski
    30. April 2012 at 20:46

    Scott wrote:
    1) “Mark, I’m not sure where you are getting those numbers from.”

    They come from Eurostat. They’re identical to the numbers the numbers that come from the ONS.

    2) “Let’s take the period since mid-2008. There’s been no change in the VAT (it went down then back up.)”

    True, but that was reflected in lower yoy HICP in 2009 and higher yoy HICP in 2011. And my point is that when one factors out indirect taxes, energy and food monthly yoy inflation in was actually quite modest in 2010 and 2011.

    3) “And not much change in energy prices–a slight fall”

    Core inflation actually averaged less than headline inflation from December 2008 through December 2011 in both the UK and the US.

    5) “Or do you think NGDP is wrong? British NGDP tracks US NGDP quite closely.”

    Actually there is a difference over this period, and I’m not even looking at 2012Q1 which likely was only 0.8% at an annual rate.

    Between 2008Q4 and 2011Q4 NGDP grew by 8.78%, and 7.66% in the U.S. and the U.K. respectively, not a huge difference but important nevertheless.

    RGDP grew by 4.21% and 1.38% in the U.S. and the U.K respectively over this period. The difference of course is the GDP deflator which increased by 4.39% and 6.19% in the U.S. and the U.K. respectively.

    I claim that energy and food prices account for the vast majority of this difference of about 1.8%.

    In the U.K. HICP increased by 10.47% from 2008Q4 to 2011Q4, core HICP increased by 7.75% and HICP minus indirect taxes increased by 7.66%. So roughly 2.5% was added to the price level by increases in energy and food prices and another 0.1% by indirect taxes. (Note also that Britain’s headline HICP is unusually higher than the GDP deflator.)

    In the U.S. the PCEPI increased by 5.53% from 2008Q4 to 2011Q4 and the core PCEPI increased by 4.53%. So roughly 1.0% was added to the price level by increases in energy and food prices.

    The difference between 2.6 and 1.0 is of course 1.6. So these three factors, indirect taxes, energy and food, would seem to account for 1.6 points out of 1.8 of the difference in the rate of increase in the price level.

    Is this an AS shock? I suppose. But food and energy price shocks are usually considered transitory, so not worth working oneself into a lather about. And most importantly, there is no great mystery, only a stubborn refusal by people to look at the actual data.

    I notice also that Simon Wren-Lewis is sounding the alarm bells over Britain’s lackluster productivity growth this recovery. Well, the U.K. is hardly alone. GDP per hour growth has slowed in almost every advanced economy. German, French and Italian productivity in 2011 was almost identical to what it was in 2007. (Interestingly, Spain’s productivity has surged.)

    My concern is that the British are working themselves into an inflationphobic fit over absolutely nothing. And this is turning into complacency when it comes to their increasingly stagnant NGDP growth.

  37. Gravatar of Ritwik Ritwik
    1. May 2012 at 00:11

    Scott

    The wage rate data (all form ONS) until now seem to support your view.

    NGDP crashed to 95.3% of its 2008 level in Q2 2009 but weekly wages went up to 101% of their 2008 levels. As of Q4 2011, NGDP is at 98.3 and weekly wages at 105.6 (full time) and 105.1 (overall) of their 2008 levels.

    But, I don’t this as ‘completing’ your contradiction of SRW’s view. For that you would also have to make the case that the total wage/labour income should be less sticky (and should track the NGDP closer than) than the wage rate itself.

    Otherwise, you could simply be drawing inferences from changes in allocation of income to profits and wages, which does not seem to offer an obvious explanation of aggregate demand.

  38. Gravatar of Morgan Warstler Morgan Warstler
    1. May 2012 at 03:35

    “My concern is that the British are working themselves into an inflationphobic fit over absolutely nothing.”

    My concerns:

    1. that you pretend people will factor out energy, food, and indirect taxes when they ask themselves if prices are going up.

    2. that EVEN THOUGH you know people will not do this…. you continue to rely on a plan that requires that they do.

    Mark, ask yourself WHAT IF energy and food WILL ALWAYS count and indirect taxes always harm?

    Now that you dont get to strip anything out, and these are the facts on the ground…. and you must change to meet the humans the way they want to be met.

    What completely new and different econ policies can you come up with that the people will support?

    !. End indirect taxes, even if you get less revenue and must shrink govt.

    2. Do whatever it takes with ending regulations to keep the cost of food and energy falling.

  39. Gravatar of Mark A. Sadowski Mark A. Sadowski
    1. May 2012 at 06:33

    Morgan,
    If you’re a monetary policy maker (the man in Threadneedle Street), and you’re going to target inflation you need to completely factor out those things. The BOE doesn’t and that’s probably why the U.K. is in a world of pain right now. (Obviously NGDP targeting done right eliminates not only the need to measure core inflation accurately, but also policymakers to some extent.)

    As consumption taxes, VAT taxes are better than many other kinds of taxes from a long run growth perspective. However, I too would prefer something more transparent (but also something more progressive).

    Energy prices, and food prices to some extent, are now largely determined internationally. I’m reasonably sure that the U.K. could fully deregulate those sectors of its economy and it wouldn’t amount to a hill of beans.

  40. Gravatar of Frederic Mari Frederic Mari
    1. May 2012 at 07:19

    Frederic, I’m afraid you completely missed the point of the post, and are putting words in my mouth. This argument has nothing to do with income distribution.

    Let me explain it this way. If your wage is $17hour, then your income is not $17/year. Do you agree? Income and wages are very very different.

    —————————–

    So I understood that. And, yes, I get that wages are different from income. However, my question was “how much different”. You say “very very”.

    Well, I am not sure if I can post clearly an internet link but this chart uses data from the BLS and BEA and,yes, there is a difference, it’s not negligeable but it’s not exactly rocking the world either…

    http://4.bp.blogspot.com/-egZi-WHPhak/T4xBrSff8yI/AAAAAAAABcE/q1RX4KaOyAI/s1600/Productivity+v.+Income+1964-2008.jpg

    Basically, I don’t think the difference between real income and real wages is very relevant. You can reason from one or from the other without making massive mistakes, I think.

    If you don’t share that opinion despite the data, then, yes, I would like you to explain further, if possible.

  41. Gravatar of Pete Pete
    1. May 2012 at 09:03

    Frederic Mari:

    Your chart reminded me of a conspiracy theory I had a few years back.

    [Uh oh!]

    The housing boom was purposefully engineered by the financial elite as a welfare program for the “99%”, because real wages have been stagnating for years.

    By artificially increasing “household income”, which of course includes home prices, thus creating a source for home equity lines of credit, re-fi’s, etc, the elite found a way to send inflation money almost directly to the people, the costs of which fell on foreign nations who were told the MBSs were AAA.

    Once the bubble burst, that pissed off many countries, who reacted by refusing to buy as many US treasuries as before, which is why the Fed is now the single largest owner of treasuries (61% of all treasuries issued last year alone).

  42. Gravatar of Frederic Mari Frederic Mari
    2. May 2012 at 05:33

    Well, so the conspiracy aspect of this is, of course, pure BS and, of course, nothing was “engineered” but, otherwise, the mechanism you describe is indeed how people felt wealthy and, not trivially, were able to sustain AD for a long period of time despite stagnating wages.

    The point remains, though – I am entirely missing the difference reasoning from real wages vs. reasoning from real income makes. The difference between the two aren’t massive, in terms of numbers.

  43. Gravatar of ssumner ssumner
    2. May 2012 at 18:09

    MF, Wrong, wages are sticky in market economies.

    Mark, I can’t imagine why food and energy prices would have increased much more in Britain than the US. What’s the intuition? Aren’t they traded in world markets?

    I still have trouble with the longer view. There’s been essentially no distortion in VAT and oil since mid-2008. But UK inflation has been substantially higher. I still don’t get it. You can’t point to oil, as oil prices are lower than in mid-2008. VAT is the same as 2008. So oil and VAT aren’t causing the high British inflation from mid-2008 to today. What is?

    Ritwik, Weekly wage data is not helpful, you need hourly data. I don’t follow the rest of your comment. Of course total wages will track NGDP better than hourly wages. Hourly wages are very sticky in the short run, hence falls in NGDP show up as falls in hours worked.

    Frederic, I don’t see what bearing that graph has on my argument. I never claimed that real wages and real incomes always move in the opposite direction. It’s no surprise they are correlated. But if Steve wants to attack sticky wage models, he needs to characterize them correctly, so that it’s clear what sort of data would be relevant for testing them. It so happens that real wages and real incomes moved in opposite directions in 2009, which is exactly the business cycle that Steve is focusing on.

  44. Gravatar of Major_Freedom Major_Freedom
    2. May 2012 at 19:05

    ssumner:

    MF, Wrong, wages are sticky in market economies.

    Sure, if your standard for judging stickiness is a fantasy land of omniscient God-like entities who alter prices instantaneously in response to every change in information on the basis of knowing all information at all times.

    Sure, prices are “sticky” because they take time to adjust, just like inflation of the money supply is “sticky” because it takes time for money to circulate through the economy once it is printed and spent by privileged parties.

    If on the other hand you use a real world standard, one that is not a fairy tale land of omniscient God-like entities who alter prices instantaneously in response to every change in information on the basis of knowing all information at all times, then one can argue that in a free market undisturbed by monetary manipulation, regulation or price controls, then we can say that prices are not sticky at all, but as maximally flexible as they can possibly get, given the reality of HUMAN action, of human knowledge, and information flow.

    To speak of sticky prices in a real world of human action is like speaking of “sticky” EVERYTHING, from production, to transportation, to selling, to consumption, to exchanges, to investment, to everything and anything that humans do that TAKES TIME.

    Where is the time in your model? Where is the fact that everything economics related takes time? Why is the standard that you are using a non-existent world of no time, no action, where things happen instantaneously?

    Since price flexibility is maximized in a free market, and because prices can and do adjust according to supply and demand, over time, it means that there is no justification for inflation to solve a non-existent problem. Wages can come down in a free market, and they do come down in theory and in practice, as 1920 showed. Wages would have kept falling if the Fed didn’t reignite inflation in 1922. Wage earners do not choose to hold out for higher wages and die from starvation. They only hold out for higher wages when there is a way for them to do so, which means wages don’t even have to fall. They only have to fall when workers have to choose between work for less, or starvation, and there, they do in fact fall. Yes, this takes time, but to call this price stickiness is ignoring the fact that all human actions take time.

    What you are really saying isn’t that prices are sticky, but that time makes events only seem sticky because everything doesn’t happen instantly.

    It would be like ignoring space, and then saying people are “alienated” and “cut off” from each other, because every individual does not take up all space, but only some space. OK, sure, call people “alienated” from each other. But does it make any sense to use the standard of “people take up all space” to judge the reality of people, and then, advocate for regulations or laws that force people to integrate, thus creating conflict? Oh wait, we already do that.

  45. Gravatar of Morgan Warstler Morgan Warstler
    2. May 2012 at 20:21

    This is a great argument:

    “If on the other hand you use a real world standard, one that is not a fairy tale land of omniscient God-like entities who alter prices instantaneously in response to every change in information on the basis of knowing all information at all times, then one can argue that in a free market undisturbed by monetary manipulation, regulation or price controls, then we can say that prices are not sticky at all, but as maximally flexible as they can possibly get, given the reality of HUMAN action, of human knowledge, and information flow.”

    Only slightly better is mine:

    “If you argue sticky wages are a “problem,” you are tacitly agreeing to any and all policy changes that reduce that problem.”

    ALL sticky price economists are so far over the line on their argument, that my GI plan 100% screws them with their pants on.

    MF is right, but nice. I’m right, but mean.

    MF thinks he’s being a purist.

    A real commitment gets off the philosophical sidelines and plays dirty.

    In liberal terms MF is a firebagger.

  46. Gravatar of Morgan Warstler Morgan Warstler
    2. May 2012 at 21:38

    Scott’s job is to make nice with Lucas:

    “He then looked at the levels of U.S. social-welfare commitments, including the new Obama health-care entitlement, and ended with a simple observation: “Is it possible that by imitating European policies on labor markets, welfare and taxes, the U.S. has chosen a new, lower GDP trend? If so, it may be that the weak recovery we have had so far is all the recovery we will get.”

    http://online.wsj.com/article/SB10001424052702303916904577378592046032370.html

    —–

    All lefties hanging here, imagine how Scott and Lucas reach accord… that’s what Scott is really doing.

    There is no room for big government or its fanboys in NGDPLT.

    Scott doesn’t have the stomach for the conflict, I know you must be bested in the street.

    One way or the other DeKrugman is dead, don’t ask us to pretend to feel bad about it.

  47. Gravatar of Major_Freedom Major_Freedom
    2. May 2012 at 23:12

    Morgan:

    Only slightly better is mine:

    “If you argue sticky wages are a “problem,” you are tacitly agreeing to any and all policy changes that reduce that problem.”

    You’re right, that’s shorter and to the point, and cuts through to the core belief.

    I submit that price stickiness is NOT an actual original “discovery” that has been arrived at “value free”, after which economists just scientifically and without any prejudice or ideology conclude that inflation is the solution. I say that in fact, it is really just an ex post rationalization, an excuse, a last ditch effort, to salvage the actual original desire for the state to inflate.

    Inflationists turn inflation upside down from its original intention (which was to enable fractional reserve banks to inflate together, so as to avoid bank runs, so as to earn more interest than they otherwise could with 100% reserve, which the state agreed to because it enabled the state an additional source of financing), to treating inflation as some sort of tonic, a solution to some non-existent problem apart from the “problem” of not being able to exploit demand deposit owners.

    And so price “stickiness” was born. With price stickiness treated as an alleged problem of the free market, the inflationists can pretend that they arrived at the “solution” of inflation “value-free.” Look folks! We’re not just advocating for inflation for our sakes! It solves the “problem” of price stickiness too! It benefits you too, because you’re too stupid and unable to instantaneously adjust prices. Silly mortals!”

    This is the thought process behind sticky prices. The Keynesians thought it up just to justify government printing and spending. The early 20th century economists who forgot everything the classicals taught, didn’t stand a chance at the sophistry. It allowed most of the economists who at the time knew falling wage rates to be the solution, which was a very unpopular and uncomfortable, to join in with the Keynesians for government printing and spending.

    This same ex post rationalization thought process also backstops the “pure and perfect competition” doctrine. This doctrine was made up by statist intellectuals, who knew the real world market could never live up to the criteria set forth, and so by treating the lack of purity and perfection in the market, it implied the magical solution that was the actual goal all along: Government regulation, anti-trust laws, printing, spending, etc, etc.

    By straw manning the free market with an absurd standard that is impossible to live up to, it made the government “solutions” seem needed after all.

    Actual economists, free market economists, don’t stoop to such low levels. You don’t see them coming up with absurd “pure and perfect government” standard, after which if the government doesn’t live up to it, then that alone justifies the market to take over the role of protection and security, i.e. anarchy.

    Here’s the pure and perfect competition doctrine:

    Market condition wherein no buyer or seller has the power to alter the market price of a good or service. Characteristics of a perfectly competitive market are a large number of buyers and sellers, a homogeneous (similar) good or service, an equal awareness of prices and volume, an absence of discrimination in buying and selling, total mobility of productive resources, and complete freedom of entry. Perfect competition exists only as a theoretical ideal.

    Here’s the pure and perfect government doctrine that I just made up:

    Government condition wherein no citizen or government has the power to alter the tax cost of a good or service. Characteristics of a perfectly competitive government are a large number of governments and citizens, a homogeneous (similar) good or service, an equal awareness of taxes and volume, an absence of discrimination in voting and legislating, total mobility of government resources, and complete freedom of entry.

    Now, since no real world government has, does, or ever will live up to this ideal, it means the market has to take control of governance, so as to bring the world closer to the ideal government. Anyone who disagrees with this is a dogmatist. Government voting is sticky. Government employees are idle. etc.

  48. Gravatar of Major_Freedom Major_Freedom
    2. May 2012 at 23:32

    Morgan:

    Scott’s job is to make nice with Lucas

    What I don’t get is how Sumner hasn’t absorbed Goodhart’s Law, which is the argument that backstops the Lucas Critique.

    Goodhart’s Law (paraphrased) says:

    “Once a social or economic indicator or other surrogate measure is made a target for the purpose of conducting social or economic policy, then it will lose the information content that would qualify it to play that role.”

    In other words, if NGDP targeting were adopted, it will lose the information content that it is supposed to convey. This means all the arguments Sumner et al are making about the CURRENT economy, of NGDP not doing this, and NGDP not doing that, this is all contingent on the fact that NGDP is not being targeted, so at best it can only contain information content, explanatory power, now.

    But if it is going to be targeted, then one will no longer be able to be say: “NGDP is growing at 5%, so that means the economy is as healthy as it can be given there is monetary inflation.” It will cease to have any explanatory power.

    In other words, the NGDP in Australia versus the US only seems to convey “This is why Australia is doing better and this is what the US is going worse”, because it’s not an explicit target there nor is it an explicit target here.

  49. Gravatar of Real Incomes = Real Hourly Wages TIMES HOURS WORKED | uneconomical Real Incomes = Real Hourly Wages TIMES HOURS WORKED | uneconomical
    14. August 2013 at 14:49

    [...] The truly remarkable data point in the 2012 statistics is the change in hours worked, which rose 2%.  The changes to hours worked is the key data point in the “productivity puzzle” so people should be well aware of this.  And falling real hourly wages plus rising hours worked is consistent with rising real incomes. [...]

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