Good news, bad news

Here’s Tyler Cowen:

No one — and I mean no one — has a coherent story about how nominal stickiness of wages lies at the heart of our current dilemma.

Good news:  I’m now a celebrity with an instantly recognizable face.

Bad news:  About that face . . . maybe a Bernanke/Krugman/Stiglitz beard would give it more gravitas.

Good news:  Yes, I’m incoherent, but the phrase “and I mean” suggests I’m the least incoherent of a bad lot.

Bad news:  He’s right, it is hard to make a sticky wage theory plausible—real wages aren’t particularly countercyclical.

Good news:  But not impossible.  Forget inflation and real wages; the key is NGDP.  If NGDP growth falls faster than wage growth, mass unemployment is almost inevitable.

I’ll do a more serious response to Tyler’s post later today.


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16 Responses to “Good news, bad news”

  1. Gravatar of Doc Merlin Doc Merlin
    11. November 2010 at 12:18

    ‘He’s right, it is hard to make a sticky wage theory plausible””real wages aren’t particularly countercyclical’

    I have serious trouble buying the sticky wage story, the sticky debts story fits better to me, and necessitates NGDP as what is important. I also worry that if we target it, it will lose its value the way targets tend to, however.

  2. Gravatar of Doc Merlin Doc Merlin
    11. November 2010 at 12:25

    I suggest a new story for cyclical unemployment that fits the micro theory better. Counter cyclical marginal costs increases. So during recessions, the marginal workers get laid off, because its more expensive to keep them hired.

  3. Gravatar of JimP JimP
    11. November 2010 at 12:54

    Good news – no bad

    A direct call for the Fed to end IOR – and clear data on the fact that it was IOR and not Lehman that produced the market crash.

    http://www.realclearmarkets.com/articles/2010/11/11/why_the_feds_qeii_will_not_work__98753.html

  4. Gravatar of JimP JimP
    11. November 2010 at 12:57

    From the above article:

    The available data indicates that it was the Fed’s IOR program, not the collapse of Lehman Brothers on September 15, 2008, that crashed the real economy and sent unemployment skyrocketing. Because the two events were only three weeks apart, many people believe that it was the Lehman bankruptcy that precipitated the worst economic downturn since the Great Depression. However, the market data from that period suggests strongly that the real cause was IOR.

    A valid way to gauge whether events are “good” or “bad” for the economy is to look at the stock market’s reaction to them. The day that Lehman Brothers collapsed, the S&P 500 went down 4.71%. Three days later (i.e., at the fourth market close after the event), the S&P 500 was down by a total of 3.61% from its pre-Lehman close.

    At the time of the Fed’s IOR announcement, the S&P 500 was down by a total of 12.18% from its pre-Lehman close, 15 trading days earlier. However, the day that the Fed announced IOR, the S&P 500 fell by 3.85%, and it was down by a total of 17.22% three days later.

    On October 22, 2008, the Fed announced that it would increase the interest rate that it paid on reserves. The S&P 500 fell by 6.10% that day, and it was down by a total of 11.11% three days later. On November 5, 2008, the Fed announced another increase in the IOR interest rate. The S&P 500 fell by 5.27% that day, and it was down by a total of 8.60% three days later.

    The stock market decline was accompanied by a plunge in employment. Total employment (BLS household survey) had fallen by 1.2 million jobs over the six months April 2008 – September 2008. During the six months after the Fed announced IOR (October 2008 – March 2009) total employment fell by 4.2 million jobs.

    The Fed knows that IOR is contractionary. Chairman Bernanke has testified that raising the IOR interest rate is one option for fighting inflation. Two Fed staff economists issued a report in July 2009 (“Why Are Banks Holding So Many Excess Reserves?”) that describes how paying IOR at the Fed Funds target rate would stop the “money multiplier” process dead in its tracks. Unfortunately, no one at the Fed seemed to realize that IOR might also stop the economy dead in its tracks (an impact that I predicted in an article published on December 9, 2008 http://www.realclearmarkets.com/articles/2008/12/why_the_economy_is_in_a_tailsp.html).

  5. Gravatar of james in london james in london
    11. November 2010 at 14:17

    Scott
    Has there ever been stagflation? What caused it? Why can’t it happen again? Why is today’s economy in the US and elsewhere so different to things back in those (1970s) days?

  6. Gravatar of John John
    11. November 2010 at 14:43

    @james in london

    I believe that someone who knew more than me would tell you that the Phillips curve becomes flat at a high rate of inflation, but that the Fed in the 60’s and 70’s didn’t realize that and kept increasing inflation whenever employment wasn’t full. Eventually when inflation gets high enough that just doesn’t work anymore and you’re stuck with high inflation and less than full employment, then you have to painfully tighten money to get inflation back to a reasonable level which is what happened.

    I also believe that this story is not controversial, but some more knowledgeable than me should weigh in.

  7. Gravatar of david david
    11. November 2010 at 15:26

    Yeah, a beard would help.

  8. Gravatar of Richard W Richard W
    11. November 2010 at 17:44

    @ JimP

    I think that article is confusing correlation with causation. The stock market had been weak or declining throughout 2008. The Lehman failure exacerbated (panicked) the problems in the shadow bank repo market. In fact, their failure was a symptom of the wider existing financing problems. As the full implications of frozen credit markets worked through the system the market crashed.

    The BoE started paying interest on reserves May 18th, 2006 without any crash in the economy or stock market. The stock market rose from there until it started to decline in January, 2008.

  9. Gravatar of scott sumner scott sumner
    11. November 2010 at 18:46

    Doc Merlin, I’m not sure why NGDP would lose its value. NGDP is the dollar value of the entire economy–how does that become unimportant?

    JimP, Thanks, that’s worth a post.

    James, The cause of stagflation is very simple—fast NGDP growth combined with slow RGDP growth. We won’t get it, because we aren’t likely to have fast NGDP growth.

    David, How about a goatee?

    Richard, Yes, it had been gradually declining, but the big crash was October and early November.

  10. Gravatar of Cameron Cameron
    11. November 2010 at 19:44

    Maybe I’m doing something wrong here… but I took BLS hourly wages/CPI, inverted it and compared it to monthly NGDP from macroadvisors.com and found a pretty obvious correlation.

    Is it really so obvious that the sticky wages explanation fails?

  11. Gravatar of Mark A. Sadowski Mark A. Sadowski
    11. November 2010 at 19:59

    Scott wrote:
    “Yes, I’m incoherent, but the phrase “and I mean” suggests I’m the least incoherent of a bad lot.”

    I can easily trump you on incoherancy in my bad moods. But at my best I’m at least as coherant as you are (and that’s saying a lot) and sometimes I’m even better than you.

    I’m proud of my monetary policy lessons and I think I’m honestly getting through to my students. I finished a case study of the GD this week. The Lost Decade of Japan is next week and the obvious conclusion follows (NGDP level targeting).

  12. Gravatar of Cameron Cameron
    11. November 2010 at 20:16

    Okay well I guess I should use real GDP rather than nominal but the correlation still stands since RGDP tracks NGDP so closely recently.

  13. Gravatar of Doc Merlin Doc Merlin
    11. November 2010 at 21:42

    @Scott
    ‘Doc Merlin, I’m not sure why NGDP would lose its value. NGDP is the dollar value of the entire economy-how does that become unimportant?’

    A number of things could cause that:
    The most obvious ones are price inflation becoming much more volatile and/or more loans being linked to some price aggregate the way TIPS are.

    @Cameron
    ‘Okay well I guess I should use real GDP rather than nominal but the correlation still stands since RGDP tracks NGDP so closely recently.’

    This is because the fed more or less targets inflation rate and unemployment. Whichever major variable the fed doesn’t target is the ones that will have, after the market adjusts to the new regime, the biggest impact on RGDP (via the Goodhart’s law) and so, in an inflation targeting regime NGDP has the biggest impact on RGDP.

  14. Gravatar of Doc Merlin Doc Merlin
    11. November 2010 at 21:46

    @Cameron:

    ‘Maybe I’m doing something wrong here… but I took BLS hourly wages/CPI, inverted it and compared it to monthly NGDP from macroadvisors.com and found a pretty obvious correlation.

    Is it really so obvious that the sticky wages explanation fails?’

    Also, you need to look at marginal wages, not average wages (I have no idea where one would get that data).

  15. Gravatar of James in London James in London
    12. November 2010 at 04:52

    “The cause of stagflation is very simple””fast NGDP growth combined with slow RGDP growth. We won’t get it, because we aren’t likely to have fast NGDP growth.”

    That’s a poor answer. You’ve merely provided another definition of stagflation, not a cause. The issue remains RGDP growth. Those, like me who believe that long-term structural and policy weaknesses in the US economy are causing low RGDP growth must begin to wonder how sincere you are in wanting these issues addressed. But then you have now bedded down with GS and the banking lobby, and insincerity is their trademark. Real structural reform is painful, the denationalisation of US housing finance and reductions in the public sector above all. US politics is too messy and too hard to influence, hence you favour the magic wand as the way out of trouble in time-honoured fashion. It’s such a shame.

  16. Gravatar of scott sumner scott sumner
    13. November 2010 at 10:03

    Cameron, Thanks for that info. It also does well in the Great Depression. I meant it wasn’t a GENERAL MODEL of recessions, as real wages don’t always rise during recessions.

    Mark, I wish I could take your course, as you’d be able to incorporate more modern macro concepts into our approach–I am deficient in technical skills, as it has been many years since I did anything with them.

    Doc Merlin, But I think it is price inflation that is unimportant.

    Yes, there are composition bias problems with real wages. I used to research real wage cyclicality, but have given up.

    James, You said;

    “The issue remains RGDP growth. Those, like me who believe that long-term structural and policy weaknesses in the US economy are causing low RGDP growth must begin to wonder how sincere you are in wanting these issues addressed.”

    Perhaps if you read one of my many posts on the need for extensive neoliberal policy reforms (such as abolishing the personal and corporate income taxes) you’d feel differently. And I favor complete laissez-faire in housing and banking.

    There’s a reason dogmatic libertarians never get anywhere—they spend most of their time attacking their allies.

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