Josh Hendrickson on the Labor Standard of Value

If you asked me to name the five greatest works of macroeconomics during the 20th century, I might produce something like the following list (in chronological order):

1.  Fisher’s Purchasing Power of Money

2.  Friedman and Schwartz’s Monetary History

3.  Friedman’s 1968 AEA Presidential address

4.  The “Lucas Critique” paper

5.  Earl Thompson’s 1982 labor standard of value paper

(BTW, Krugman’s 1998 expectations trap paper might well make the top 10.)

Most economists would replace Thompson’s paper with something like the General Theory by Keynes.  In this post I explained why this 2 page never published paper that looks like something out of the Middle Ages is so important. (Please look at the link; the paper’s formatting is hilarious.)  Thompson’s student David Glasner did some excellent work on this idea in the late 1980s.

Josh Hendrickson has a new Mercatus paper which explains the logic behind the Thompson proposal.  Although Josh’s paper is very clear and well written, I can’t resist adding a few comments, as I fear that the extremely unconventional nature of Thompson’s idea might make it hard for some people to grasp the significance.

Josh starts off with an analogy to a gold standard regime, and then discusses the well-known drawbacks of that approach.  With a gold standard regime, any necessary changes in the real or relative price of gold can only occur through changes in the overall price level (or more importantly NGDP), which can be disruptive to the economy.

Here I’d like to emphasize the importance of the issue of sticky prices.  Adjustments in the overall price level can be costly because many nominal wages and prices tend to be sticky, or slow to change over time.  In contrast, gold prices are very flexible, changing second by second to assure that the gold market stays in equilibrium.  Under a gold standard, the nominal price of gold is fixed, and thus the ability of gold prices to quickly adjust is in a sense “wasted”.  Instead, we ask stickier prices to adjust when the real price of gold needs to change.

When reading Josh’s paper, try to keep sticky wages in the back of your mind.  Whenever the aggregate nominal wage level needs to adjust unexpectedly, some wages will be slow to change, and will be out of equilibrium for a certain period of time.  If there is downward wage inflexibility, especially a reluctance to cut nominal wages, then labor market disequilibrium can persist for years.

Normally, when we think of a government program aimed at fixing a price (gasoline, rents, etc.) we think of a market that is pushed out of equilibrium.  Nominal wage targeting is different.  Under Thompson’s proposed regime, individual nominal wages are still free to change, but monetary policy is adjusted until labor market participants do not want to change the aggregate average nominal wage rate.  In that case, the aggregate average nominal wage should stay at the equilibrium level (although of course individual wages might still occasionally move a bit above or below equilibrium.)

Under our current system, a sudden fall in nominal wage growth actually leaves the aggregate nominal wage too high, as some wages have not yet adjusted downwards.  We’d like to prevent that, by providing enough money so that the aggregate average nominal wage does not need to adjust.

My second comment has to do with the mechanism that Josh discusses:

Suppose that the central bank promised to buy and sell gold on demand at its current market price, but guaranteed that an ounce of gold would buy a fixed quantity of labor, on average. This is a promise to keep an index of nominal wages constant.

This approach is called indirect convertibility, a subject that Bill Woolsey discussed in a series of papers published in the 1990s.  I have a couple brief comments.  First, this sort of scheme need not involve gold at all.  Second it’s essentially a form of “futures targeting”, which is something I’ve done a lot of work on myself.  Indeed, this idea was independently discovered by numerous economists during the 1980s, but Thompson was the first.

If you are having trouble understanding the logic behind the indirect convertibility mechanism for a labor standard, think about the fact that aggregate wage data comes out with a lag, and hence you need to target a future announcement of the wage index.  To assure that monetary policy is set at a position where expected future wages are stable, you need a futures market mechanism where investors could profit any time aggregate wages are expected to move.  Their attempts to profit from wage changes nudge monetary policy back to the stance likely to keep average wages stable.

In addition, the specific proposal discussed by Josh involves a stable wage level, but given political realities it’s more likely the actual target would creep upward at 2% to 3%/year.

Also note that Josh argues that a labor standard is a vastly superior approach for achieving the goals of recent “job guarantee” proposals, put forth by progressives.  I agree.

PS.  I have a new Mercatus Bridge post discussing a WSJ article that called for monetary reform aimed at stable money.

PPS.  My recent post at Econlog on the usefulness of the yield spread got zero comments, which surprised me given all the recent focus on that variable.



33 Responses to “Josh Hendrickson on the Labor Standard of Value”

  1. Gravatar of Rajat Rajat
    1. August 2018 at 13:27

    Only just realised the RSS link to EconLog was broken! I have commented there on your yield curve post.

  2. Gravatar of Anon Anon
    1. August 2018 at 17:44

    Isn’t it economic orthodoxy that wages are more downwards sticky than upwards? And if so, isn’t it highly inefficient to have wages be on-aggregate stable instead of on-aggregate rising, since aggregate stability means some wages want to decline and are therefore out of equilibrium?

    It’s not just “political realities” that justify a 2-3% wage increase, it’s that such an increase is much more efficient in a world where wages are sticky downwards but not upwards.

  3. Gravatar of Matthias Goergens Matthias Goergens
    1. August 2018 at 19:04

    Thanks for pointing out the paper. I shall read it.

    I first really got free banking (and more sympathy for the historic gold standard), when I read George Selgin explain how competitive note issue would stabilise nGDP given a stable size of the monetary base.

    Because of network effects, even with free banking a voluntary gold standard will probably never return as long as there are at least a few stable national fiat currencies. We can see in the wild how countries with broken economies get a black or grey market dollarisation but I don’t think we’ve seen a ‘goldisation’ like thar.?

  4. Gravatar of Willy2 Willy2
    1. August 2018 at 22:27

    – Friedman and Schwartz are – when it comes to monetary policy – two economists who simply “don’t get it”. They were even wrong when it came to giving an explanation for the events happening in the 1970s. So why would have a credit at all ?

  5. Gravatar of dtoh dtoh
    1. August 2018 at 22:48

    On the yield curve.

    Very briefly it comes down to is it cheaper to borrow (or conversely can I get a better investment yield) now or in the future. So as concrete example, if borrowers expect a recession (and corresponding lower rates), they will borrow short term now (raising short term rates) and hold off on borrowing long (lowering long term rates) with the net effect being a flattening of the yield curve.

    It’s important to remember that borrowers and investors are looking at real rates so a positive yield curve can also be an indicator that the market expects a continuing buoyant economy to result in higher future inflation so that a nominally positive yield curve actually corresponds to a flat real yield curve and an expectation of steady real economic growth.

    Now let’s consider the current flat yield curve. I believe that a reasonable argument could be advanced that with a) reduced tax rates, b) a low LFPR, and c) relatively low inflation numbers, the market believes that the new normal is steady high growth with relatively steady inflation.

    And BTW with effective monetary policy, the yield curve would always be flat and bond traders would be out of job.

    Come to think of it, the FOMC and most monetary economists would also be out of work. Maybe that’s why the profession has been slow to embrace NGDPLT.

  6. Gravatar of Rajat Rajat
    1. August 2018 at 23:50

    Just in case you don’t go back to the Econlog post, here it is:

    Agree with (1) and (2). I think (3) is also right, but the yield curve inversion signal tends to occur 1-2 years out from a recession. Probably rate cuts within the year prior to a recession cause the inversion to disappear. This is consistent with what you’ve said before, that central banks like the Fed are slow to shift into gear and like to move ‘deliberatively’. This means that while they cut rates as they notice the economy slowing, they cut too late and too little to prevent recessions – hence no ‘mini-recessions’.

    This leaves the question of why the Hypermind market is not giving any warning that the Fed is close to triggering a recession. Maybe it needs to look further out in advance? Maybe it just doesn’t have enough participation to be efficient? Tyler Cowan’s conversation with Vitalik Buterin was interesting in this regard.

    Whatever the reason, I think we have to be very careful in dismissing a metric that has been a useful and correct early-warning signal over the last 40 years or so.

  7. Gravatar of Kenneth Duda Kenneth Duda
    2. August 2018 at 06:56

    Scott, would a more modern-feeling version of Thompson’s approach be a variant of NGDP targeting where the monetary authority adjusts the supply of fiat currency to peg the nominal value of a wage future to a target path? i.e. this is identical to NGPD targeting but using the wage level as the pegged nominal variable instead of NGDP. If true, this seems like a very good approach for all the same reason NGDPLT is a good approach. I’m not sure how much it matters which nominal aggregate you target. Targeting either of these would be so much better than current policy!

    The indirect convertibility aspect makes it much harder for me to understand. I have no intuition for the zinc-price of an hour of labor or why the government should spend any time thinking about how much zinc it takes to buy an hour of labor. I guess there’s no way to directly peg the price of labor (because the government isn’t going to buy/sell enough of it), so Earl pegs the price of zinc rather than pegging a futures contract, which was maybe easier to understand in 1982, which was maybe before derivatives were well understood?


  8. Gravatar of Will LS Will LS
    2. August 2018 at 07:53

    Surprised you left out kydland and prescott time inconsistency paper

  9. Gravatar of Christian List Christian List
    2. August 2018 at 08:41

    Why would this be better than NGDP targeting? I assume it wouldn’t be better, so let’s forget about it.

    It also sounds way more difficult to understand, so politicians and the public won’t get it and therefore reject it.

    NGDP targeting on the other hand is easy to understand. Even I got it, and that says a lot.

  10. Gravatar of sean sean
    2. August 2018 at 11:11

    “the Fed already has some of the best forecasters, why rely on market expectations when there is no evidence that markets can predict business cycles better than the Fed?”

    Not sure why anyone would think this. Found it in the old article. If the market is efficient then how would the FED higher the best forecasters if their pay skill tops out at under a million.

  11. Gravatar of ssumner ssumner
    2. August 2018 at 11:37

    Thanks Rajat.

    Anon, I agree. You can debate whether wages would become more downward flexible with a 0% growth target, but I’d rather not take that chance.

    dtoh, I think it’s simpler. Yield curves tend to invert before recessions because rates tend to fall during recessions. But yes, they fall because there is less demand for credit. I’d guess the current yield curve is predicting slower but positive growth ahead. If nominal growth was expected to continue at this pace, long term rates would be higher, and the yield spread would be closer to its normal 1% or so.

    Ken, I agree about indirect convertibility. I also agree that a wage target might be better than an NGDP target. I’ve advocated NGDP for two reasons. It seems more politically feasible, and it seems more “robust”, that is, it would do pretty well even if the sticky wage model is wrong.

    Will, I’m not sure that paper has held up well over time. It doesn’t seem like the time inconsistency problem has pushed central banks towards excessive inflation, at least in recent years.

  12. Gravatar of dtoh dtoh
    2. August 2018 at 14:59


    I think you may be assuming the relationship between the growth rates the Wicksellian rate is constant. We may be in a new world of abundant capital where the Wicksellian rate has fallen relative to the growth rate.

  13. Gravatar of Benoit Essiambre Benoit Essiambre
    2. August 2018 at 16:01

    What about in the future when most jobs are automated and wages aren’t really a thing anymore, when people all live off of dividends?

  14. Gravatar of ssumner ssumner
    2. August 2018 at 19:58

    dtoh, I agree, but I don’t think it’s fallen that much.

    Benoit, I’ll never live long enough to see that happen. Indeed this is one of the tightest labor markets I’ve ever seen. The level of service is falling sharply (everywhere I go), as businesses seem short of labor.

    I am skeptical of the theory that new jobs won’t arise to replace those taken by machines.

  15. Gravatar of Rajat Rajat
    2. August 2018 at 23:01

    “Under our current system, a sudden fall in nominal wage growth actually leaves the aggregate nominal wage too high, as some wages have not yet adjusted downwards. We’d like to prevent that, by providing enough money so that the aggregate average nominal wage does not need to adjust.”

    In light of the first sentence, should it be “…so that the aggregate average nominal wage growth rate does not need to adjust.”?

  16. Gravatar of dtoh dtoh
    2. August 2018 at 23:39

    Just one further thought on this. I have in the past explained how the increasing asymmetry of returns on investments (e.g. 1000 failed businesses for every Apple) will reduce expected after-tax returns even when tax rates are held constant, and that this will result in reduced investment and reduced real economic growth.

    I also believe that another effect of increasing the asymmetry of returns is to cause an increase in the spread between the risk free (i.e. Treasury) rate and the actual economic growth rate. If we assume the Wicksellian rate correlates to some risk weighted average return on all economic activity and by extension to the real growth rate of the economy, and if we further assume that the asymmetry of those returns has widened, then this would cause ceteris paribus the after tax spread between risky investments and risk free investments (e.g. Treasuries) to narrow. However, since investors are rationale they will react by requiring a higher pre-tax differential in rates between risk free and risky investments. This will cause some widening in the nominal spread between Treasuries and the natural (Wicksellian) rate. In other words, Treasury yields should fall relative to the rate of growth of the economy.

  17. Gravatar of rayward rayward
    3. August 2018 at 10:42

    “You could argue that if the Fed is doing its job properly, any recession should have been impossible to predict ahead of time.” I have complimented Sumner for his observation that the economy is most in need of help when it appears least in need. He didn’t get it, telling me that my compliment was nonsense. I could have made the opposite point, that the economy is least in need of help when it appears most in need. What about today? Least in need, or most in need? To be consistent, Sumner would respond that what’s most in need is a futures (prediction) market to accurately predict the future so policy makers don’t have to guess, and guess wrong all too often. Of course, when prediction markets prove to be fallible, we could have prediction markets of prediction markets. And then prediction markets of prediction markets of prediction markets.

  18. Gravatar of ssumner ssumner
    3. August 2018 at 17:41

    Rajat, Yes.

    dtoh, That’s plausible, but I doubt the change has been particularly dramatic in the past 5 years.

  19. Gravatar of Benjamin Cole Benjamin Cole
    5. August 2018 at 01:37

    OT but a segment from a fascinating article from Michael Pettis, professor of finance at Guanghua School of Management at Peking University in Beijing.

    “In other words, to the extent that imbalances have persisted for many years, or even decades, they must be sustained by policy distortions in either the surplus or the deficit country. In such cases, if a country is forced to absorb the distortions generated by another country, and it implements trade intervention policies aimed at reversing the effects of these distortions, these policies benefit both the first country and the global economy, although usually at the expense of the country where the distortions originated.

    This has become an especially important argument in recent years. Distortions in the distribution of domestic income in several countries (most importantly, in China, Germany, and Japan) have led to huge savings imbalances, which are automatically absorbed by countries that have deep, flexible, and completely open capital markets with strong legal and governance institutions (mainly the United States and, to a lesser extent, the UK and other so-called Anglo-Saxon economies). The result has been that the former countries have run large, persistent surpluses for decades, while the latter have run large, persistent deficits. Policies among the trade-deficit countries aimed at reversing these imbalances can be justified as economically efficient and to the benefit of the deficit countries.”

  20. Gravatar of Becky Hargrove Becky Hargrove
    5. August 2018 at 10:21

    Josh’s paper seemed to contain some of the same production norm logic that is attributed to George Selgin – especially given the tradable sector assumptions of gradually falling prices. Of course, much of the sticky wage problem stems from non tradable sector nominal claims, which are also affected by the fact more labour has come online in recent decades. Which is why it might help to have a market intermediary for a managed form of convertability which would make it possible to create decentralized settings for a non tradable sector production norm.

  21. Gravatar of Becky Hargrove Becky Hargrove
    5. August 2018 at 10:40

    Sorry for the misspelled word, it’s convertibility.

  22. Gravatar of Morgan Warstler Morgan Warstler
    5. August 2018 at 12:01

    Kudlow hits homer

  23. Gravatar of Larry Larry
    5. August 2018 at 13:43

    Here’s my question:

    There’s economic theory and arguments about economic theory. And then there’s power politics.

    In America, probably elsewhere as well, the rich, powerful and corporate get laws passed that they want much more so then ordinary citizens get laws passed that they want.

    How does this power play, with people as losers, effect economic theory?

    I never hear this issue discussed. It’s always market does this and that. It’s always interest rates do this and that.
    It’s always economic theory says this or that…

    As far as I am concerned if you ignore power plays by the rich, powerful, and/or corporate, you cannot do accurate economic analysis.

    As far as I am concerned if you ignore power plays by the rich, powerful, and/or corporate, you are burying your head in the sand.

    Though on the other hand if you are an economist, it’s still a good living.

  24. Gravatar of Benjamin Cole Benjamin Cole
    5. August 2018 at 20:09



    In macroeconomics, there are oceans of certitude behind diametrically opposing theologies, although conflicting high priests insist they are guided only by principle and logic.

    That is why economists look down on physicists.

    “Look at you, you pathetic little physicist,” said the economist. “The laws of physics mutate as new empirical observations are made. But our laws are immutable!”

    Some people say macroeconomics is just politics in drag.

    Too cynical, I say.

    I say that view is too cynical (about cross-dressers).

  25. Gravatar of Scott Sumner Scott Sumner
    6. August 2018 at 08:00

    Ben, He’s wrong about trade imbalances, they are not problems and they are not necessarily caused by policy distortions. Are you also concerned about trade imbalances between American states? Why or why not?

    Morgan, That’s almost laughably wrong. The budget deficit is skyrocketing upwards, contrary to the predictions of supply-siders. It’s exploding. The worst fiscal policy in American history.

    Larry, Ignore? Ever heard of public choice theory?

  26. Gravatar of Scott Sumner Scott Sumner
    6. August 2018 at 08:01

    Becky, Yes, it’s related to the Selgin proposal.

  27. Gravatar of Larry Larry
    6. August 2018 at 15:09


    I’ve heard about public choice theory. I am no expert. Yet, you do not mention public choice theory in your post. So you are not paying much attention to that theory either.

    So the question remains: To what extent are economic questions answered by looking at the advantage that the rich, powerful, corporate have over our laws (and lives) or by looking at NGDP, RGDP, interest rates, market actions, etc.

    You might also want to consider what effect powerful multinational corporations have in evading regulations by any one country.

    Perhaps, one day, you will consider yourself a citizen of Goldman Sachs or Apple rather than the United States of America.

  28. Gravatar of Becky Hargrove Becky Hargrove
    6. August 2018 at 16:57


    Much depends on the extent to which corporations decide to use price making, instead of price taking, as a long term strategy. The latter effectively coordinates markets, while the former tends to distort the whole process. Once a given product is on the market long enough for knowledge of its production to disperse, corporations which opt for price taking can contribute to falling prices (particularly in tradable sectors) which contribute to rising standards of living.

    The problem arises when too many corporations utilize price making indefinitely, which means they are either not willing or able, to contribute to the falling or relatively constant price level which many economists understandably seek to target. In a services dominant economy, price making reduces both market capacity and labour force participation. Yet it’s difficult to discern how much is actually lost, since much of this is presently categorized as intangible product. If more corporate activity could commit to price taking strategies in the near future, monetary policy would ultimately have a chance to be far more effective than it is today.

  29. Gravatar of Benjamin Cole Benjamin Cole
    6. August 2018 at 23:27


    I understand conventional trade theories, Ricardo, absolute and comparative advantage.

    I did take an interesting regional (US) economics course (back in the gas-lamp era, when I was in college).

    By the flickering light, I read regional economies have a few ways to earn income: 1) export goods and services; 2) tourism; 3) tax money in (relevant for state capitals, or DC). The rest is taking in each other’s laundry. I suppose a region can seek investment capital—-but it should be invested capital, and not borrowing.

    To answer your question, yes, if I lived in Detroit (and I could not migrate away) I would be worried about Detroit’s trade balance with other cities, regions and states.

    Did you know that Detroit was the world’s richest city, per capita, in 1960? Singapore was not.

    Starting in the 1970s, Singapore did everything it could to attract, retain, support, subsidize and protect industry. It is very pro-business and smart. It worked. Singapore today is some sort of statist corporatist nirvana, public-private ying-yang and checkered soup.

    Singapore’s GDP PPP is now 50% higher than the US.

    Detroit chose a different path, that of de-industrialization. Blame unions, arrogant white-guys management, minorities, stupid government, anything you want.

    The results can be seen of Detroit’s de-industrialization policy, and subsequent trade deficits with other regions.

    In fact, in recent years California has shipped $60 billion or more in taxes to DC more than it gets back in federal outlays. I think that particular “trade deficit” results in lower incomes and wealth in CA. Does it not (ceteris paribus)?

    There is something amiss with simple global free trade theories.

    Certainly, nations in the Far East have evolved by eschewing free trade theories, and operating government and industry hand-in-hand to exploit export markets and protect domestic markets.

    Perhaps Michael Pettis, professor of finance at Guanghua School of Management at Peking University in Beijing (cited above) is “wrong.” He claims theoretical underpinnings for his stances.

    I am more practical. I look at what works.

    Maybe there is a theory that if a nation wants capital to take risks, there must be some measures of protection. After all, why build a factory in the US, if factories globally can be subsidized and then export to the US?

    Is de-industrialization really a good national economic policy?

    See Detroit.

  30. Gravatar of ssumner ssumner
    8. August 2018 at 07:43

    Larry, First you say economists don’t consider these issues, then you tell me you are aware of public choice theory, then you complain I didn’t discuss public choice in a post that has nothing to do with the subject.

    Ben, Detroit’s problems have nothing to do with its regional trade balance. California ran a consistent deficit during the golden years when it grew very fast. South Korea ran a deficit during the 1970s and 1980s, when it grew at more than 10%/year.

    You said:

    “Certainly, nations in the Far East have evolved by eschewing free trade theories,”

    This is idiotic. Singapore and Hong Kong have far more free trade than the US. You seem to be about the only person in the world that doesn’t understand that fact.

  31. Gravatar of Prakash Prakash
    8. August 2018 at 10:09

    Targetting labour with futures, agreed. But a more significant question might be – target average income or median income?

  32. Gravatar of Andrew Andrew
    20. August 2023 at 18:56


    Under the Thompson/Hendrickson proposal, which actor(s) in the United States federal government would need to take action (and what kind of action) to implement the “Labor Standard”/wage price targeting? Thanks!

  33. Gravatar of ssumner ssumner
    21. August 2023 at 13:12

    Andrew, The Fed would use open market operations (and/or interest on bank reserves) to stabilize an index of nominal wages.

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