Wage stability is a feature, not a bug

Arnold Kling posed the following hypothetical:

Consider the following thought experiment. Call what we actually did–the bailouts, the stimulus, the actual path of monetary policy–plan A. Suppose that in March of 2008, when folks were contemplating a bailout of Bear Stearns, the Fed instead had gone with Plan B, in which Ben Bernanke says, “Folks, it looks like there is going to be some heavy weather ahead on Wall Street. A lot of firms are in shaky situations. I want everyone to know that, no matter what happens, (a) we are not going to do anything to assist any individual firm; and (b) we are not going to allow nominal GDP to fall below the path in our forecast, which calls for an increase of 5 percent per year.”

.   .   .

Would the market response to Bernanke’s promise to maintain nominal GDP have resulted in the economy remaining closer to full employment? I can think of three channels.

1. Wage rates. If anything, workers who believed the hypothetical promise to maintain nominal GDP would have been less likely to make wage concessions. Thus, this goes the in the wrong direction.

If workers start making wage concessions then you’ve lost the war.   They’ll never be big enough.   Get ready to be voted out of office and replaced by another government.  Nominal wage concessions are the last thing you want.  And I agree with Arnold that nominal wage gains might have actually been slightly higher under 5% NGDP targeting adopted in early 2008—perhaps 4% instead of 3%.  But here’s what matters, wages/NGDP would have risen far less in 2008.  As it is, the ratio rose by about 7% (3% wage gains and 4% NGDP decline from 2008:2 to 2009:2.)  That sudden increase made high unemployment almost inevitable.  With a 5% NGDP target and 4% nominal wage gains, the ratio would have actually fallen about 1%, resulting in much higher employment levels than what actually occurred.

One of the most important goals of NGDP targeting is to make nominal wage growth stable, so that any needed adjustments in real wages would occur via price level changes.

PS.  I agree with Arnold’s claim that 3% NGDP growth in 2009 would have been dramatically better than what actually occurred.  Why didn’t the Fed do at least that much stimulus?

HT:  123


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14 Responses to “Wage stability is a feature, not a bug”

  1. Gravatar of Benjamin Cole Benjamin Cole
    2. May 2012 at 16:38

    http://www.econ2.jhu.edu/People/Ball/BB%20and%20ZB.pdf

    According to the above, Bernanke came under the influence of an on-staff Svengali Vincent R. Reinhart, and other currency-fetishists and Theo-Monetarists in the institution.

    The Fed has become a perverted milieu, polluting inhabitants.

    Too far I go?

    Consider that Richard Fisher, Dallas Fed President, went to Japan in 2009…and then pompously pettifogged about the evils and “rot” of inflation. His sanctimonious sermonette was delivered to a nation in the two-decades-and-running chronic grip of a deflationary perma-recession. It is a perversion to suggest to Japan that inflation is “rot.” Like warning an anorexic of the dangers of fatty foods or that men will never marry a fat woman.

    If that is the ilk that inhabit the Fed, Bernanke needs a lot of help—consider what the Reagan White House did in 1984, when they thought money was too tight. They applied pressure, threatened to move control over Fed policy to the White House.

    The Brazilian President is more interested in current Fed policy than the US President, judging from the number of speeches both have made about US monetary policy. Obama is out to lunch, on our most important macro-economic policymaking institution.

    Look for the “L-shaped” recovery long promised by economists. Perhaps minus the recovery part.

    http://www.dallasfed.org/news/speeches/fisher/2009/fs090408.cfm

  2. Gravatar of Steve Steve
    2. May 2012 at 16:50

    @Ben

    An “L shaped” recovery is better than a “\ shaped” recovery.

    You need to have realistic expectations. We did have a financial crisis after all :(

  3. Gravatar of Greg Ransom Greg Ransom
    2. May 2012 at 16:56

    It ain’t stimulus.

    If you are doing NGDP targeting you are not doing Keynesian Exon and you are NOT doing “stimulus”.

    Misuse the language, loose the debate, middle the conversation, botch your understanding of the subject at hand.

  4. Gravatar of Greg Ransom Greg Ransom
    2. May 2012 at 16:57

    Foiled by the IPad spell checker again ….

  5. Gravatar of Benjamin Cole Benjamin Cole
    2. May 2012 at 17:04

    Steve-

    I have expectations that people in vital positions of power will try to hew to the best policies…but those expectations are not being met. The Fed is radically failing, in the same slow-motion that defines the Bank of Japan.

    Boy, the Reagan White House pulled off the gloves and went after Volcker tooth-and-nail for the jugular vein. I can’t think of any cliches to describe Obama’s myopic mincing about.

  6. Gravatar of marcus nunes marcus nunes
    2. May 2012 at 17:10

    I agree with Arnold’s claim that 3% NGDP growth in 2009 would have been dramatically better than what actually occurred. Why didn’t the Fed do at least that much stimulus?
    That´s easy. Because Bernanke thought that by rescuing the financial system he would avoid clogging the credit channel which to him is the most important transmission mechanism.
    Unfortunately he had to learn the hard way that his 1983 paper is not very good!

  7. Gravatar of Steve Steve
    2. May 2012 at 18:23

    @Ben

    I agree and I very much like your posts.

    Sometimes I indulge in black humor because it is all I have.

  8. Gravatar of Major_Freedom Major_Freedom
    2. May 2012 at 19:20

    ssumner:

    If workers start making wage concessions then you’ve lost the war. They’ll never be big enough. Get ready to be voted out of office and replaced by another government. Nominal wage concessions are the last thing you want.

    So the reason you don’t want a free market in wages, is because we don’t have a free market in wages. It’s all political to you, and not economics.

    Nominal wage concessions are the first thing you want, because it can increase employment for those who want to work, and in a depression, can increase total wage payments, as postponed investments are made once again. Sure, wage rates are lower, but lower wage rates means lower costs of production, and that means lower prices.

    And I agree with Arnold that nominal wage gains might have actually been slightly higher under 5% NGDP targeting adopted in early 2008—perhaps 4% instead of 3%.

    Which means higher costs of production, which means no change to profitability.

    But here’s what matters, wages/NGDP would have risen far less in 2008. As it is, the ratio rose by about 7% (3% wage gains and 4% NGDP decline from 2008:2 to 2009:2.) That sudden increase made high unemployment almost inevitable. With a 5% NGDP target and 4% nominal wage gains, the ratio would have actually fallen about 1%, resulting in much higher employment levels than what actually occurred.

    Nope. You’re fallaciously assuming that aggregate demand finances wages. It doesn’t. Wages come out of savings and capital, not aggregate demand. Aggregate demand is what results from spending on consumer and capital goods, including the spending from wage earners.

    One of the most important goals of NGDP targeting is to make nominal wage growth stable, so that any needed adjustments in real wages would occur via price level changes.

    This comes at the cost of making the capital structure of the economy unstable.

    PS. I agree with Arnold’s claim that 3% NGDP growth in 2009 would have been dramatically better than what actually occurred. Why didn’t the Fed do at least that much stimulus?

    According to Bernanke, it was because he didn’t want the Fed to lose credibility. He said that higher prices (which higher NGDP would have resulted in) would have made the Fed lose the credibility it has worked so hard to attain over the years. Those are his words.

  9. Gravatar of Benjamin Cole Benjamin Cole
    2. May 2012 at 19:53

    Steve-

    If there was something blacker than black humor, I would indulge in that.

  10. Gravatar of Saturos Saturos
    3. May 2012 at 01:51

    Scott, in the next paragraph Kling writes:

    “2. Domestic investment. In theory, investment projects should have looked more promising. But which ones? Not housing or commercial development in the “sand” states. Construction activity elsewhere? Factories? Computers? Maybe we can tell a story in which stock market investors do not sell stocks, Tobin’s q does not fall, and so investment does not fall. Or maybe not. Perhaps the declines in the stock prices of financial stocks would have been even worse and more long-lasting.”

    Previously, you said:

    “<i?Actually Kling said they could, but the result would be high inflation. He’s skeptical it would help RGDP very much.”

    Sounds to me like Kling doesn’t believe that a target would boost spending. That would be consistent with his earlier opinions: http://econlog.econlib.org/archives/2009/12/some_thoughts_o.html

  11. Gravatar of ssumner ssumner
    3. May 2012 at 08:27

    Ben, That Ball article has gotten a lot of attention–it’s quite good.

    Greg, I can’t always spell things out in detail or I’d be blogging 24 hours a day. I have to assume readers will understand the context.

    Marcus, But he prevented a much worse disaster! :)

    MF, I never said I opposed a free market in wages, where did you get that idea?

    Saturos, That seems more like RGDP to me, but perhaps you are right. If so, then the last part of his post makes no sense.

  12. Gravatar of 123 123
    3. May 2012 at 08:39

    @Marcus, Bernanke did not unclog the credit channel. Did you notice how investment grade bonds crashed in late 2008?

  13. Gravatar of Major_Freedom Major_Freedom
    3. May 2012 at 09:03

    ssumner:

    MF, I never said I opposed a free market in wages, where did you get that idea?

    When you started advocating NGDP targeting with the expressed purpose of altering nominal wages via non-market means.

  14. Gravatar of TheMoneyIllusion » Thanks for asking TheMoneyIllusion » Thanks for asking
    3. May 2012 at 12:33

    [...] In a recent post I argued that falling wages were a really bad sign.  Some commenters thought I opposed wage cuts.  Just the reverse, if we are stupid enough to let NGDP fall, wage cuts are an excellent idea.  I want wage flexibility at the micro level, and a monetary policy that produces stable wage growth at the macro level.  If the central bank targets inflation, wage cuts will even boost NGDP. [...]

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