I have no idea what “nominalism” is, but I think I’m going to like it

I’ve never liked the way textbooks treat macro.  They have an intro to money section with some basic accounting (MV=PY) and also the quantity theory of money (which 99.9% of students and 90% of economists think is somehow related to MV=PY.  It isn’t.)  There’s discussion of the German hyperinflation from a sort of hot potato perspective.  And then . . .

. . . and then it’s all dropped.  Then we go into Keynesian chapters where NGDP = C + I + G + NX and money affects interest rates and inflation is caused by “overheating economies” (like Zimbabwe?)

[Update:  Alex Tabarrok reminded me that the Tabarrok/Cowen text is an exception.]

I always thought the “classical dichotomy” provided the natural framework for explaining macro to students.  There’s the nominal economy, and there’s the real economy.  We could explain the nominal economy with a monetary (hot potato) framework and the real economy by assuming nominal shocks have real effects due to sticky wages and prices.  What could be simpler?

In this framework the AD curve is relabeled NE (nominal expenditure) and is a hyperbola.  Monetary theory explains why that hyperbola shifts northeast or southwest, and sticky wages and prices explain why the SRAS is upward sloping and the LRAS is vertical.  No need to throw out those early money chapters; you can tell students the “MV stuff” explains why the NE curve shifts left and right.

We would also de-emphasize “inflation shocks.” Recall that we should never “reason from a price change,” because inflation from the demand-side is a totally different phenomenon than inflation caused by supply shocks.  On the other hand we should always and everywhere reason from an unanticipated NGDP change, because those affect employment in predictable ways, regardless of whether they hit a healthy economy (1929) or an economy ravaged by debt problems (2008.)  They cause employment fluctuations.  Period, end of story.

Is it possible that we are starting to move to a NGDP-oriented view of the economy?  Perhaps this is just wishful thinking on my part, but I couldn’t help thinking that the reference to “nominalism” in this Financial Times article was hinting at an NGDP approach to macro:

While investors may have realised that a less rigid focus on inflation targeting will mean a shift in favour of equities and away from bonds, it is less clear that equity managers, or corporate managements, have realised that this change in the monetary policy framework in favour of “nominalism” will have a profound impact on the type of equities that outperform in coming years.

On the other hand, I was disturbed by this:

A significant change in monetary policy is under way around the world. From Abenomics in Japan, to the greater flexibility just afforded to the Bank of England with regards to pursuing its inflation target, and the Federal Reserve introducing an explicit unemployment target, it is clear that the days of inflation targeting are numbered.

The focus on lower inflation has lasted more than 30 years, resulting in three decades of falling inflation. In the US it dropped from 12 per cent in 1979 to below 2 per cent before the credit crunch hit. The policy also produced a 30-year bull market for bonds, as US Treasury yields fell from more than 15 per cent in the early 1980s to below 4 per cent by the mid-2000s.

However, this success in beating inflation has been achieved at the cost of a declining share of labour in national income.

It is not a coincidence that the share of labour in GDP peaks in the 1970s for both the US and the UK. Given that the largest element of costs was – and remains – labour, the fight against inflation amounted to a campaign to squeeze labour incomes.

Monetary contraction in 1981-82, and again in 1991, did temporarily raise unemployment.  But tight money has no long run effect on the share of national income going to labor, as wages and prices will eventually adjust to the new inflation rate.  And in the short run a contractionary policy can (sometimes) actually raise real wage rates (although) of course it reduces total real income earned by workers.

When two long run trends happen at the same time, don’t assume one causes the other.

HT:  Nicolas Goetzmann


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42 Responses to “I have no idea what “nominalism” is, but I think I’m going to like it”

  1. Gravatar of Gregor Bush Gregor Bush
    9. April 2013 at 06:51

    Scott,

    This is something I’ve been thinking about. And I agree with you that in equilibrium labour’s share is unaffceted by monetary policy. But if central banks over a period of 35 years persue “opertunistic disinflation” (lowering inflation targets following recessions) does this not imply a falling labour share over the period in which they do this? Also, if a central bank is assymeteric in it reaction function with a bias toward low inflation and wages are “stickier” than other prices, does this have an effcet on labour’s share?

    My prior is that the answer to the second question is “probably not” but the answer to the first question is “yes”.

  2. Gravatar of Geoff Geoff
    9. April 2013 at 06:56

    “We could explain the nominal economy with a monetary (hot potato) framework and the real economy by assuming nominal shocks have real effects due to sticky wages and prices. What could be simpler?”

    Individual action, which is responsible for the real economy and the nominal economy, prices, price adjustment speeds, and real and nominal shocks?

    “But tight money has no long run effect on the share of national income going to labor, as wages and prices will eventually adjust to the new inflation rate.”

    Both tight money and loose money tend to affect the wage share of national income, in the direction of decreased share. This is because inflation adds to aggregate demand, and the incomes derived from aggregate demand are profits, not wages. Wages adjust upwards yes, but those upward adjustments are constrained by the upward adjustment in sales revenues, which generate profits. Hence, any temporal volatility in this relation, where sometimes wages rise faster than profits, and sometimes profits rise faster than wages, will tend to be biased towards relatively higher profits and relatively lower wages, over long periods of time.

    This is consistent with empirical history:

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

    Since the early 1970s, a time when the last constraint to inflation was lifted, wage share has consistently fallen.

    Wage share of national income cannot keep up in a monetary system that adds spending to aggregate sales revenues (aggregate demand).

    Keynes had it right:

    “Lenin is said to have declared that the best way to destroy the Capitalist System was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security, but at confidence in the equity of the existing distribution of wealth. Those to whom the system brings windfalls, beyond their deserts and even beyond their expectations or desires, become “profiteers,” who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished, not less than of the proletariat. As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.”

    “Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.” – Economic Consequences of the Peace, VI 13-14.

    I think it takes willful ignorance to believe that inflation affects everyone’s income equally. I think there is a psychological incentive to disbelieve Cantillon, because of the consequences to one’s own pro-inflation convictions.

  3. Gravatar of Saturos Saturos
    9. April 2013 at 06:59

    Ken Rogoff on secular decline in rates: http://www.project-syndicate.org/commentary/why-are-long-term-interest-rates-so-low-by-kenneth-rogoff

    Justin Fox on Bitcoin: http://blogs.hbr.org/fox/2013/04/building-a-better-bitcoin.html

  4. Gravatar of mpowell mpowell
    9. April 2013 at 06:59

    I’d have to 2nd Gregor Bush’s point. Can we really call it the long run when we’re really referring to a period where the fed has been steadily lowering inflation expectations? And if so, you really have to be careful about the utility of arguments about what will happen in ‘the long run’ if 30 years doesn’t qualify.

  5. Gravatar of Saturos Saturos
    9. April 2013 at 07:00

    And Tyler linked to this piece on the Netherlands: http://www.spiegel.de/international/europe/economic-crisis-hits-the-netherlands-a-891919.html

  6. Gravatar of Justin Irving Justin Irving
    9. April 2013 at 07:18

    I wonder if Geoff stands on busy street corners, holding cardboard signs with his comments from this blog written in all caps with a felt tip marker…

    The FT is so hit or miss. I lost faith in them during the debate over the Swiss currency ceiling and their use of the word “drama” regarding Greece. How does monetary policy affect the composition of NGDP? Falling labor share it pretty clearly tech driven. We have a standard Smithian/Say’s Law economy for skilled workers and a near-Malthusian economy for the unskilled.

  7. Gravatar of Blackadder Blackadder
    9. April 2013 at 07:23

    Nominalism is the metaphysical position according to which there are no universals. According to Richard Weaver, it is responsible for the decline of Western Civilization.

    My guess is you would, in fact, like it.

  8. Gravatar of Randomize Randomize
    9. April 2013 at 07:25

    Dr. Sumner,
    Do you have any thoughts on the government switching to the Chain Weighted CPI? Would, by lowering the reported inflation level, the Fed’s nominal inflation target effectively become higher?

  9. Gravatar of RebelEconomist RebelEconomist
    9. April 2013 at 07:25

    “….the quantity theory of money (which 99.9% of students and 90% of economists think is somehow related to MV=PY. It isn’t.”

    I think I am with the 90% (except that I prefer T – for value of transactions – in place of Y), but how would you explain the QT of money, Scott?

  10. Gravatar of Geoff Geoff
    9. April 2013 at 07:27

    Blackadder:

    >Weaver’s ideal society was that of the European Middle Ages, when the Roman Catholic Church gave to all an accurate picture of reality and truth (Nash 94).

    I’ll take a “decline” in Weaver’s opinion any day.

    FYI: Nominalism as used in this economics discussion is not metaphysical. It is relating to monetary policy rules.

  11. Gravatar of Geoff Geoff
    9. April 2013 at 07:29

    Justin Irving:

    “I wonder if Geoff stands on busy street corners, holding cardboard signs with his comments from this blog written in all caps with a felt tip marker…”

    Only when the Holy Fed is criticized. Then I hold signs saying “Please reduce my purchasing power and save me from having to decide for myself what money I use!”

    And I write it in crayon.

    With the r’s backwards.

  12. Gravatar of Bill Woolsey Bill Woolsey
    9. April 2013 at 07:30

    Scott:

    Have you ever noticed all of that stuff about long run growth in the macro books?

  13. Gravatar of Ashok Rao Ashok Rao
    9. April 2013 at 07:53

    “Monetary contraction in 1981-82, and again in 1991, did temporarily raise unemployment. But tight money has no long run effect on the share of national income going to labor, as wages and prices will eventually adjust to the new inflation rate. And in the short run a contractionary policy can (sometimes) actually raise real wage rates (although) of course it reduces total real income earned by workers.”

    Curious to know how a contractionary policy can (in the short run) raise wages?

    Also, I don’t know how wrong the FT article was. Sure everything you say is correct, but inflation is ultimately a tax on capital. And when you de-tax capital you would expect falling labor share of income.

    Of course you might not agree with the sentiment implicit, but the point seems to be consistent.

  14. Gravatar of ssumner ssumner
    9. April 2013 at 07:54

    Gregor and mpowell, I don’t see how, as the real effects just occur for a few years after the two disinflations (1981 and 1991). By the late 1990s labor’s share should be back to normal. The problem is that “normal” is falling.

    Blackadder, I like that too! Except that NGDP is a universal.

    Randomize, The Fed targets the PCE, not the CPI. I don’t have strong views, as there is no “correct” measure of inflation.

    Rebeleconomist. MV=PY is just a definition of V, nothing more. The QTM says an increase in M causes a proportional increase in P or NGDP (two versions.) Another version says M and NGDP are highly correlated. So there are different versions of the QTM, none has anything to do with MV=PY.

    Bill, I’m fine with that. I just don’t like the way they integrate the monetarist and Keynesian stuff. It’s a complete mess and not 1 student in 1000 understands what’s going on.

  15. Gravatar of ssumner ssumner
    9. April 2013 at 07:57

    Ashok, That’s not the argument they made, but in any case I doubt that the result has to do with taxes. Is the before-tax share of income going to capital not also rising?

    If nominal wages are sticky and prices fall due to contractionary policies, then real wages will rise. This happened in 1921 and 1930.

  16. Gravatar of ssumner ssumner
    9. April 2013 at 08:00

    Saturos, I used to think the euro worked reasonably well for the Dutch, now even that doesn’t seem correct.

  17. Gravatar of Ashok Rao Ashok Rao
    9. April 2013 at 08:03

    Scott, I agree that the before-tax share/real value going to capital is increasing, but regardless inflation ipso facto decreases capital investment, increasing labor share, right?

  18. Gravatar of ssumner ssumner
    9. April 2013 at 08:04

    Saturos, I’d expect interest rates to stay low for the foreseeable future, even though they will eventually rise above zero. But not far above.

    I have no opinion on bitcoins, I focus on MOA not MOE.

  19. Gravatar of Dan S Dan S
    9. April 2013 at 08:34

    Speaking of nominalism the philosophical position, am I the only one who finds it strange that there are STILL people who disagree with it? It strikes me as going against everything we know about science and a physical universe. Right? Shouldn’t it be obvious at this point that the essences of things don’t reside in a higher universe, that words are just useful labels we use to describe what makes objects similar in a relevant-to-the-situation way? I think Scott with his pragmatism would be all over that.

  20. Gravatar of RebelEconomist RebelEconomist
    9. April 2013 at 08:40

    I think you are being too dogmatic, Scott. I have an old Palgrave Dictionary of Money in which the Quantity Theory entry is written by Milton Friedman. Equation (1) is MV=PT.

  21. Gravatar of Tommy Dorsett Tommy Dorsett
    9. April 2013 at 08:46

    Scott — Any idea why so many otherwise smart people seem to believe AD is driven by supply-side forces such as demographics? It seems to be a huge blind spot in which many people fail to distinguish between the composition of spending (micro) and the volume or total spending (AD, MV, NGDP and the central bank). Also why the recent rally in Japan equities took many by surprise…..

  22. Gravatar of ssumner ssumner
    9. April 2013 at 09:51

    Ashok, Less investment may raise labor’s share, but reduce their real income. I’d add that the effect you describe is not large enough to be statistically significant. Investment has been pretty stable.

    Rebeleconomist, I’m sure Friedman never claimed the equation of exchange was the QTM. You probably misinterpreted what you read. Not only is it not the QTM, it’s not even a theory of any kind, so it obviously cannot be the QTM.

    Tommy, Good point.

  23. Gravatar of ssumner ssumner
    9. April 2013 at 09:52

    Dan, I agree, But I’m surprised no one has commented on the “nominalism” in the article. I was quite interested in knowing what the authors meant by the term, and no commenter has offered an opinion.

  24. Gravatar of Ashok Rao Ashok Rao
    9. April 2013 at 09:55

    “Ashok, Less investment may raise labor’s share, but reduce their real income. I’d add that the effect you describe is not large enough to be statistically significant. Investment has been pretty stable.”

    Right, this is why I’m not arguing that a capital tax is a good thing, per se, but why it might take part in explaining shifts in income share.

    If a change in inflation between 12% and 2% , in terms of labor share dynamics, isn’t statistically significant, does that mean you don’t think that an annual 10% tax on all savings would not increase labor share (at a huge cost, granted).

  25. Gravatar of TallDave TallDave
    9. April 2013 at 09:58

    Randomize, The Fed targets the PCE, not the CPI.

    Does Commerce or Fed track aggregate non-personal prices too? I wonder if they diverge much, seems possible for non-personal inflation to be negative while PCE/CPI are positive. Of course, the calculation is still going to be a mess.

  26. Gravatar of TallDave TallDave
    9. April 2013 at 10:05

    “Nominalism” seems to mean “less rigid focus on inflation targeting” or something closer to NGDPLT.

    Although, the Austrian in me wants to shout “Down with ordinalism, up with nominalism!” 🙂

  27. Gravatar of RebelEconomist RebelEconomist
    9. April 2013 at 10:05

    Presumably Milton Friedman thought that MV=PT was at least “somehow related” to the QTM, Scott, which puts him in the 90% too.

  28. Gravatar of Peter Peter
    9. April 2013 at 10:14

    “It is not a coincidence that the share of labour in GDP peaks in the 1970s for both the US and the UK.”

    I wonder if they did the same error as a recent tv program in Sweden did. They hadn’t accounted for capital depreciation.

    http://super-economy.blogspot.se/2013/02/looking-closely-has-labor-share-of.html

    See also this on UK: http://www.forbes.com/sites/timworstall/2012/09/26/labours-share-of-the-national-income-is-falling-but-is-it-being-measured-the-right-way

  29. Gravatar of ssumner ssumner
    9. April 2013 at 10:37

    Rebeleconomist. Does the word “the” also appear in that essay? And does Friedman think the QTM is “somehow related’ to the word “the.”

    And if there is a relationship to MV=PY, what is it?

  30. Gravatar of RebelEconomist RebelEconomist
    9. April 2013 at 11:06

    Friedman describes it as the “transactions form of the QUANTITY equation” (my emphasis). If you want to know how he thought it relates to the QTM, read the article yourself.

  31. Gravatar of Doug M Doug M
    9. April 2013 at 12:49

    You start you Macro class with an intro to money?

    I began with a picture of a man and a factory and a series of arrows represting consumption and wages. This went straigt into Keynes followed by little bit more Keynes. Then NAIRU, the Johnsons “two wars”, Nixon’s Oil shocks, a touch of monetary theory and the term was over.

    My next class was Keynes, followed by IS-LM models.

    I am all for getting rid of AD curves.

  32. Gravatar of Becky Hargrove Becky Hargrove
    9. April 2013 at 13:25

    Scott,
    For me, the FT article was fascinating, if perhaps a bit puzzling in the attempted market forecasts, because they had clearly been thinking in nominalism terms for a while. Here’s my guess: someone who (also) thinks in labor terms has nonetheless picked up on NGDPLT as a reversion to the importance of individual economic actors, thus the name nominalism. I have to chuckle just thinking about it because now, labor stands tall with producers! Before this wild notion gets dismissed out of hand…it actually leads to a quite sensible path which was hinted at in the article when the authors observed:

    “As governments move to more ‘debtor friendly’ monetary regimes, rather than the ‘creditor friendly’ regimes of the past three decades, the corporate sector will be unable to be a simple observer. Imaginative group structures, rather than the imaginative financial engineering of the past decade, will become increasingly necessary.”

    For one thing, there’s a lot of truth in that last sentence: our institutions need to be turned inside out and reframed, in order to capture knowledge skills wealth that was not available when they were created. In that sense of course ‘imaginative group structures’ would not look at all like earlier versions of labor owned coops or businesses. Perhaps nominalism might be associated with new forms of group arbitrage. Such arbitrage would include local (non-tradable) economic activities under coordinated “umbrellas”, where capital wealth flows from decisions in knowledge use structures. This would make possible “just in time” knowledge use, skills inventories and algorithms (based on shifting desires of participation and learning) much as they exist in tradable goods today.

  33. Gravatar of ssumner ssumner
    10. April 2013 at 06:43

    Rebeleconomist, Yup, it’s the transactions form of the quantity equation, and no, I don’t want to read it for myself, because I already understand the distinction.

    Doug, No.

    Becky, I’m not sure what a “debtor friendly” monetary regime is.

  34. Gravatar of Becky Hargrove Becky Hargrove
    10. April 2013 at 07:24

    Scott,
    It seems to be an assumption that with nominal targeting, some of the more “exotic” financial instruments would be taken off the table, given the room for their existence would be more tightly defined.

  35. Gravatar of Joe Eagar Joe Eagar
    11. April 2013 at 00:23

    I’m not sure I buy that inflation targeting doesn’t distort labor’s share of the economy. If nothing else, an overemphasis on inflation makes central banks reluctant to allow labor markets to fully tighten during expansions. Removing this distortion is supposed to be one of the selling points of NGDP targeting, isn’t it?

  36. Gravatar of ssumner ssumner
    11. April 2013 at 07:05

    Joe, Or fully weaken during recessions.

    No, under NGDPLT policy is even tighter during expansions.

  37. Gravatar of Mark A. Sadowski Mark A. Sadowski
    11. April 2013 at 13:03

    The labor share of income during the age of disinflation has declined pretty much everywhere in the advanced world.

    Peak Core CPI Rate*, Peak and Recent Labor Share of Income (Total Economy) (*Except Portugal)

    Nation——CPI-Year– Peak-Year-Recent-Year-Change
    US———-12.4-1980-69.6—1980-63.7—2010–5.9
    Japan——-20.2-1974-72.5—1977-56.6—2009-14.9
    Germany——6.8-1974-76.3—1974-68.5—2011–7.8
    UK———-22.1-1975-75.6—1975-71.3—2010–4.3
    France——12.7-1980-79.2—1981-68.4—2010-10.8
    Italy——-22.3-1980-83.4—1971-68.1—2010-15.3
    Spain——-26.4-1977-76.4—1977-59.9—2011-16.5
    Canada——11.1-1980-68.1—1971-59.8—2008–8.3
    Australia—12.8-1977-75.5—1975-61.3—2006-14.2
    Neth.——-10.5-1975-77.1—1975-68.5—2010–8.6
    Sweden——12.5-1980-77.9—1978-63.3—2011-14.6
    Switzerland–8.9-1974-67.5—2002-65.9—2010–1.6
    Austria—–11.1-1981-98.5—1978-66.3—2011-32.2
    Norway——12.2-1981-73.7—1977-55.4—2011-18.3
    Portugal*—33.1-1977-83.9—1975-66.4—2010-17.5
    Denmark—–10.6-1978-73.7—1980-69.5—2011–4.2
    Finland—–17.5-1975-76.9—1991-66.1—2011-10.8
    Ireland—–21.2-1981-79.3—1980-60.9—2010-18.4
    New Zeal.””–17.2-1982-60.7—1975-49.0—2006-11.7

    The international labor share data comes from the OECD and is not consistent with BEA data.

    Although there are many reasons for the increase in inequality that we have seen in the US and in other parts of the world (less progressive taxation, weaker unions, lower minimum wages, globalization, Skills-Based-Technological-Change (SBTC) etc.) the leading hypothesis for why there has been such large scale declines in the labor share of factor income almost everywhere in the OECD is disinflation (i.e. tight monetary policy).

    Disinflation during the eighties and the nineties was accompanied by a significant rise in the profit share of national income in most OECD countries or, equivalently, by a reduction in the labor share. This suggests that changes in the rate of inflation are non-neutral with respect to the distribution of factor income. The consequences of inflation upon inequality thus may largely be the indirect result of the effects of inflation upon factor shares. The mechanism by which this comes about is fairly simple. Accelerating inflation is correlated to falling unemployment rates, falling unemployment rates lead to greater labor bargaining power, and greater labor bargaining power is correlated with lower markups. Furthermore, higher inflation rates create greater price dispersion leading to greater competition among producers to limit markups. This hypothesis was tested with a panel of 15 OECD countries over the period from 1960 to 2000 and a robust positive relationship between inflation and the labor share was obtained:

    http://pareto.uab.es/wp/2000/46000.pdf

  38. Gravatar of ssumner ssumner
    12. April 2013 at 05:34

    Mark, You said;

    “the leading hypothesis for why there has been such large scale declines in the labor share of factor income almost everywhere in the OECD is disinflation (i.e. tight monetary policy).”

    Wow. 45 years after Friedman/Phelps and economics has reverted to the Stone Age.

  39. Gravatar of Geoff Geoff
    12. April 2013 at 06:18

    Dr. Sumner:

    “No, under NGDPLT policy is even tighter during expansions.”

    The investment errors that accumulate from the lack of profit and loss signals in money production don’t go away even with a fixed NGDPLT.

    For NGDPLT, the unobservable errors that accumulate can be inferred from the accelerating rates of money growth needed to maintain NGDPLT.

  40. Gravatar of Mark A. Sadowski Mark A. Sadowski
    12. April 2013 at 06:54

    Scott,
    I fail to see any contradiction at all between this and Friedman/Phelps.

  41. Gravatar of ssumner ssumner
    12. April 2013 at 12:49

    Mark, The natural rate hypothesis says labor markets eventually adjust to changes in the rate of inflation, and hence money is neutral in the long run. Or did I misunderstand what those guys are claiming?

  42. Gravatar of Sumner, Apostle of the New Religion of Nominalism | Last Men and OverMen Sumner, Apostle of the New Religion of Nominalism | Last Men and OverMen
    18. April 2017 at 03:43

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