NGDP and sticky wages

When NGDP growth falls 8% below trend, revenues also fall 8% below trend.  Or much more than 8%, if you are a state like California with a fiscal regime all leveraged-up like a hedge fund.

But public employee wages and pensions do not fall 8% below trend, creating massive fiscal deficits.  One solution is to have the Fed bring NGDP all the way back to trend.  That won’t happen, and indeed at this point I’m not sure it should.   What did happen is that after mid-2009 NGDP growth continued to fall further and further below trend, worsening the fiscal situation of state governments.  Inevitably, you eventually end up with the following:

Still, discussions about something as far-reaching as bankruptcy could give governors and others more leverage in bargaining with unionized public workers.

“They are readying a massive assault on us,” said Charles M. Loveless, legislative director of the American Federation of State, County and Municipal Employees. “We’re taking this very seriously.”  [New York Times]

That’s right, 2 1/2 years after NGDP started plunging, states are “readying” an attempt to bring their costs in line with falling NGDP.  Still think wages aren’t sticky?

The Times also had this interesting tidbit:

Meet the new banking system, same as the old banking system

And then there is this article:

Oregon was one of the few to buck that trend. Last January, voters approved a temporary increase in taxes for individuals making more than $125,000 a year and on couples whose income exceeded $250,000. An editorial in The Wall Street Journal later stated that these rates caused thousands of upper-income residents to flee the state, but studies revealed that a large majority simply made less money, and so fell beneath the income cutoff for the higher rates.

If I was a twenty-something high tech worker in Portland making 60k to 80k, I’d certainly expect to make over 125k at some point in my career.  Thus I’d move up to Washington where there is no state income tax.    And I’d do it now, not when in my 40s with kids in the public schools.

Another example of how income distribution data is misleading.


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25 Responses to “NGDP and sticky wages”

  1. Gravatar of Dirk Dirk
    22. January 2011 at 11:17

    Good argument.

    After thinking more about your post on how homes have remained vacant… isn’t that good evidence that, for whatever reason, home prices must be sticky? If not, wouldn’t they have dropped to their market clearing prices some time over the past two years?

    If home prices are sticky then printing more money should boost wages faster than home prices.

    Since there are so many sticky wage skeptics, despite your good arguments here, perhaps focusing on the housing market instead of the labor market would make for a more powerful case among the AD doubters. Are people doubting home prices are behaving in a sticky fashion?

  2. Gravatar of Morgan Warstler Morgan Warstler
    22. January 2011 at 11:41

    Scott if this is your way of saying we need to gut the public employee unions immediately and should have been doing it 2.5 years ago – SINCE we’re not going to get 8% more NGDP from the Fed, this is a funny way of saying it.

    Do you just not look in some messy closets in your house?

    Ya know Milton Friedman would not make a simple link to “Meet the new banking system, same as the old banking system”

    Any more than he’d miss the opportunity to scream, “Public Unions are a scourge, and Paul Krugman is an effete twit with posing as an economist.”

    Red meat makes your motives clear, doing damage to the public unions, putting them back on their heels INCREASES the chances of your policy objectives.

  3. Gravatar of Benjamin Cole Benjamin Cole
    22. January 2011 at 12:27

    I realize that taxes are important–but really, have many times have you met someone who says they live in Manhattan, or Red Bluff, Las Vegas, or Sacramento because of the tax climate? Once in while, I hear someone has moved to Incline Village in NV, to get away from CA taxes.

    Also, there seem to be an overemphasis in the media not on the average tax rate but the marginal top tax rate. One gets the feeling that a 14 percent average rate, but a 50 percent top rate, is not preferable to an 18 percent average rate, but a 30 percent top rate.

    That said, I would like to see the federal government pegged to 16 percent of GDP (we could get there by sunsetting USDA, Commerce, HUD, Labor, Education, and cutting defense by 75 percent). I suppose states can go their own way, but setting a ceiling makes sense to me.

    It is outrageous that our US Congress, when discussing what to cut, do not mention USDA, Commerce, HUD, Labor, Education, and cutting defense by 75 percent, but rather entitlements. In other Congress wants to keep its goodies. The Red State Socialist Empire will prevail.

    Did you know that CA, with our broke government, for decades has poured about $50 bil. a year more into DC than we got back?

    As a high-income state, we pay a lot in federal taxes, but the spending is tilted to rural states.

  4. Gravatar of Indy Indy
    22. January 2011 at 12:37

    Bankruptcy is not about “Boy, we sure made a bunch of, what seem in retrospect, to be very unwise promises (the performance upon which people justifiably relied in their decisions to lend, or be employed by, the state), and the liability for which it would be awfully convenient to escape now.” The concept behind bankruptcy is that some entity *cannot, by any reasonable means* bring in the requisite revenues to meet its liabilities.

    For a business, the justification is that those revenues can only be obtained voluntarily from customers, and that the business can already be expected to do everything within their power to maximize profits.

    For a municipality, the justification is that though they have coercive taxation power, they are too small in geographic scope to prevent tax-exodus vicious cycle, since people can continue to “benefit” from city tax expenditures (for example, driving in the city that has to pay to plow the roads, but living just across the tax jurisdiction line – like the citizens of income-tax-less Vancouver, Washington do when they shop in lower-sales-tax Portland, Oregon.)

    Look at Bell, California; Hamtramck, Michigan; Kansas City, Missouri, or maybe even Harrisburg, Pennsylvania, and you’ll see some of this forum effect.

    This is, essentially, a *Laffer Curve* argument. “We’ve reached the empirical (not political) end of our extent of our ability to derive more revenues from our taxation powers, some kind of default is unavoidable, and we therefore need relief.” This is especially convincing when your community is little more than a “company town” (either private or government) and that “company” is hit the skids or is closing down.

    There is the alternative argument that “some kind of unforeseen disaster has destroyed our *short-term* ability to meet our obligations, and though we intent to pay back our creditors, we need the legal cover to reschedule and restructure the payments”. This is the Orange County / New-Orleans-post-Katrina scenario.

    But for states, with huge territories and populations, “sticky industries” that find it hard to move away quickly, and highly variegated economies, the “escape” argument remains true, especially for highly-mobile Americans, but is much less powerful an argument. States should have to make just such a “Laffer case” to demonstrate they’re really at the end of their ability to fulfill their promises – just like a business or city can.

    Are California or Illinois there? Well, Illinois just raised their MTR by 2/3rds, and while it’s possible they’ll disappear eventually, most of the citizens have decided to stay put in the short-run. There’s no *short-term* reason to think they can’t solve their deficit through adjusting spending and taxes.

    What about California? Well, California has a little law called AB32 – the Global Warming Solutions Act. Part of this law requires that California motor-fuel consumption decline quite significantly. That’s going to be done through the price mechanism, and that means taxes, but demand for motor-fuel is not very elastic.

    California sells 15 billion gallons of gasoline and 5 billion gallons of diesel fuel every year. A tax that caused retail price increase of 40% (Slightly over a dollar a gallon, about the amount needed to reduce consumption to target levels), would make lots of people very grumpy (though motor fuel is a small percent of most people’s regular bills, and they mostly applauded AB32 which essentially requires it, a mysterious contradiction) but it would solve almost the entirely of California’s current deficit – as well as have numerous positive spill-over effects on their famous traffic congestion and urban sprawl.

    So, as soon as higher taxes cause so many people and businesses to leave the state that the state literally *cannot* raise more tax revenue (this may be Greece or Ireland’s fate soon enough), and until they have cut state-services to the levels where it would be unreasonable (standards vary) to ask for any more spending cuts – no one should even be talking about “bankruptcy” for states.

  5. Gravatar of tom tom
    22. January 2011 at 13:23

    This post reminds me of a question I have had, but haven’t really sought the answer to.

    In terms of profits and productivity how much have wages remained “sticky” during this downturn for the private sector? Since wages are up slightly on average, but down in aggregate a large amount due to UE, and productivity has been high, and profits are high.

  6. Gravatar of Greg Ransom Greg Ransom
    22. January 2011 at 13:43

    Firemen in Orange County make $100,000 a year and can retire at full $100,000 income at age 50.

    A good number make far more than $100,000, and spike their retirement income via “final year” pay including bank sick leave and vacation time pay.

    The solution is bankruptcy and receivership for the state of California and its cities and counties — California should be declared in violation of the U.S. Constitution (its a swindle scheme, not a republic) and it should be returned to territorial status with a Federally appointed territorial governor.

  7. Gravatar of Greg Ransom Greg Ransom
    22. January 2011 at 13:49

    Note well, these government union wages / entitlement problems were at the heart of the problems in the German Weimar (reparations weren’t really very significance) — see Niall Ferguson, _The Pity of War_, which includes a nice take down of Keynes.

  8. Gravatar of Greg Ransom Greg Ransom
    22. January 2011 at 13:49

    Note well — the money expansion solution to the government sticky wages / entitlements problem didn’t go so well in the Weimar Republic.

  9. Gravatar of Dustin Dustin
    22. January 2011 at 14:29

    maybe that’s because the Weimar wasn’t targeting anything like NGDP, and in fact was printing money for a whole other reason..?

  10. Gravatar of scott sumner scott sumner
    22. January 2011 at 14:31

    Dirk, They are both sticky, but wages are way more sticky. Home prices have fallen sharply. There may be some reason for leaving a home empty. Suppose the rent falls short of the cost of maintaining a rented home, but the market is expected to improve sharply in 5 years. That might be why some homes are empty, not just sticky house prices.

    Morgan, I like sushi more than red meat–maybe that’s why you and I never seem to see eye to eye.

    Benjamin, You said;

    “I realize that taxes are important-but really, have many times have you met someone who says they live in Manhattan, or Red Bluff, Las Vegas, or Sacramento because of the tax climate? Once in while, I hear someone has moved to Incline Village in NV, to get away from CA taxes.”

    Not Manhattan or Sacramento, but I have met people who say that about Vegas and New Hampshire.

    You said;

    “That said, I would like to see the federal government pegged to 16 percent of GDP (we could get there by sunsetting USDA, Commerce, HUD, Labor, Education, and cutting defense by 75 percent). I suppose states can go their own way, but setting a ceiling makes sense to me.”

    I strongly agree on that.

    Indy, It will be interesting to see how this plays out–I don’t have strong views either way.

    Tom, Hourly wages have fallen much less than NGDP, making unemployment almost inevitable.

    Greg, Did Weimar target 5% NGDP growth, or 500,000,000,000% NGDP growth?

  11. Gravatar of scott sumner scott sumner
    22. January 2011 at 14:32

    Dustin, Exactly.

  12. Gravatar of Mark A. Sadowski Mark A. Sadowski
    22. January 2011 at 14:46

    Scott,
    This will be somewhat off topic so bear with me.

    “When you think of the economy, think of a rain forest that you live in and study, not a machine that you fix.”
    Arnold Kling

    Since I spent some venom disparaging Kling recently I’d thought that I might start by quoting one of the most eloquent things I think he’s ever said. And in the spirit of that quote let me say the following.

    Back in 2004 I read the following paper by CBPP that pointed out that the share of net national income growth in the recovery from the 2001 recessions was unprecedented for a postwar recovery:

    http://www.cbpp.org/archiveSite/9-3-04ui.pdf

    Note Table One. In the first 10 quarters of the recovery from the 2001 recession 46.9% of Real Net National Income (RNNI) growth went to corporate profits. This compared to 20.8% for the postwar average (excluding that recovery).

    We’re only five quarters into the current recovery. However, how does it compare so far? So far 76.7% of the growth in RNNI has gone to corporate profits. Needless to say this is totally unprecedented.

    I have a theory as to how this has come about and as to why it appears that it is a trend in recent recoveries: sticky wages. Not on the way up of course, but on the way down. Here’s how it works.

    Relatively low inflation rates coupled with a recession lead to relatively large increases in unemployment compared to the reduction in AD. (It also potentially leads to inefficient rates of sectoral wage adjustments and recalculation.) High levels of unemployment lead to labor market slack during the recovery phase which in turn lead to modest growth in compensation relative to growth in other forms of income.

    Interesting, huh?

    I have no beef against corporations. After all my father was one. (Warrender Inc.) I’m just “studying the rain forest” and find the current recovery to be fascinating. (And I believe it corroborates the notion of sticky wages.)

  13. Gravatar of Mark A. Sadowski Mark A. Sadowski
    22. January 2011 at 16:05

    “share of net national income growth in the recovery from the 2001 recessions was unprecedented”

    should read:

    “share of net national income growth in the recovery from the 2001 recession going to corporate profits was unprecedented”

    Problems with my laptop!

  14. Gravatar of Morgan Warstler Morgan Warstler
    22. January 2011 at 16:09

    Mark,

    1998 Public Employee Compensation F, S & L): $918B
    2010: $1.7B If it grew at inflation it would be $1.2T

    That’s disgusting.

    $500B PER YEAR is close to SS, Defense, or Medicare.

    If they didn’t make it – we’ll have almost no deficit to concern ourselves with.

    If you like Keynes, you KNOW he’d agree – during the boom times, we were not supposed to give public employees those raises.

    Pretty interesting, huh?

  15. Gravatar of Mark A. Sadowski Mark A. Sadowski
    22. January 2011 at 16:19

    Yeah, but Morgan, being the social parasite that you think I am, I depend on the public sector for part of my compensation. You wouldn’t begrudge me that, would you?

    By the way, Happy New Year! (You !@#$%^& !@#$%^&.)

  16. Gravatar of Full Employment Hawk Full Employment Hawk
    22. January 2011 at 18:02

    ” That won’t happen, and indeed at this point I’m not sure it should.”

    What ever happened to LEVEL targeting?

    You are right that if the Fed maintain NGDP level targeting even in the face of wage cuts, reductions in mominal wages will reduce unemployment. But since you indicate that it will not be doing this, the effects of wage reductions may not reduce unemployment because it will increase the rate of disinflation and push the economy toward deflation. The effects of this on expectations has a contractionary effect.

  17. Gravatar of Full Employment Hawk Full Employment Hawk
    22. January 2011 at 18:07

    “Still think wages aren’t sticky?

    While union power can make nominal wages more sticky, unions are not the cause of sticky wages in market economies. They are an intergral feature of real world market sytems and the result of the fact that nominal wages are not continuously and simultaneously adjusted downward (or upward) to continuously clear labor markets. Rather they are adjusted discretely for significant periods of time and sequentially, rather than simultaneously.

  18. Gravatar of Full Employment Hawk Full Employment Hawk
    22. January 2011 at 18:23

    “When you think of the economy, think of a rain forest that you live in and study, not a machine that you fix.”

    That is a piece of advice that I totally reject. It is a recepie for failure. Rather:

    Think of an economy that is depressed as a sick patient that needs to be and can be treated and cured. The fact that our ablity to treat some diseases, like cancer, is limited at the present time, does not cause medical doctors to not do the best they can to cure the patient.

    Both expansionary fiscal and expansionary monetary policy can, if pursued strongly enough, restore the economy in a reasonable time frame. For example Hjalemar Horace Greely Schacht had the German economy back to full employment by 1936. The fact that what he did is largely ignored in the English speaking world is a major ethnocentric blindness.

    As far as the U.S. economy at the present time, the current political situation makes more expansionary fiscal policy impossibe. (Obama missed his chance to do this in 2008.)
    At the present time monetary policy is the only game in town for restoring the economy to full employement in a reasonable amount of time. Therefore debates about fiscal versus monetary policy, while of great academic interest, are irrelevant with respect to what is currently needed to restore the economy to full employment.

  19. Gravatar of Mark A. Sadowski Mark A. Sadowski
    22. January 2011 at 18:33

    FEH,
    Although I’m sympathetic I think I’m of the most use by remaining in the rain forest. Please don’t disturb my reverie.

  20. Gravatar of Mike Sandifer Mike Sandifer
    23. January 2011 at 04:15

    Scott,

    Would a better measure of income distribution be the distribution of GDP over various demographics? GDP is essentially aggregate income, right?

  21. Gravatar of Mike Sandifer Mike Sandifer
    23. January 2011 at 04:18

    Morgan,

    If the Feds came in to replace falling state spending/revenue, these costs would be small. Way too much is focused on this “problem”.

    Naturally, raising NGDP may be the best response, but otherwise the Feds can easily make up the difference.

  22. Gravatar of scott sumner scott sumner
    23. January 2011 at 18:57

    Mark, That’s a good theory, and it’s undoubtedly part of it. Another part is that the recovery has been really weak in the US and strong in the developing world. Half of corporate profits come from overseas (and in companies like GM, it’s the vast majority of profits.)

    Full Employment Hawk, I still support level targeting, but one can’t hold on to the same starting point forever. What if in the year 2087 we are 47% below trend from 2008–do we shoot for 47% NGDP growth? The point is to reflect the needs of the economy, based on when wage and debt contracts are signed. That’s always evolving. We’re about 9% below trend from mid-2008. I favor much more than 5% NGDP growth over the next year, but much less than 14%. I’m not quite sure what is optimal at this point. If we got even 7% or 8% I’d be thrilled.

    You said;

    “While union power can make nominal wages more sticky, unions are not the cause of sticky wages in market economies.”

    I agree.

    I actually agree with Kling’s view that the economy is not like a machine to be managed. I don’t favor managing RGDP. Managing NGDP is really just managing a tiny corner of the economy, the value of the medium of account. We already managing, the question is whether we do it well or poorly.

    Mike, I’d look at labor income inequality–ignoring capital income, or consumption inequality.

  23. Gravatar of Jim Caserta Jim Caserta
    23. January 2011 at 20:02

    I thought part of Keynsianism is for gov’ts to deficit spend during recessions and anti-deficit spend (run surpluses) during good times. Because a large portion of gov spending is on pension benefits for employees, you get the exact opposite. During good times, returns exceed program targets, putting the programs in surplus. So states contribute LESS to their pensions during good times. Then in recessions, returns go below target showing massive deficits. To which, govs try to spend MORE to their programs, making their budget situation worse. This is one of the main arguments against defined-benefit programs. You should really just contribute a set percentage of ones income per year and let the chips fall.

    For the past 10 years we’ve been running cyclical policies – making the economy run hotter (cut taxes and have the fed keep rates too low), and now there is a massive push to cut budgets. Let’s draw up a way for governments to make the boom-bust cycles as bad as possible, and I don’t think it would be that much different than what we’ve been doing.

  24. Gravatar of Ed Dolan Ed Dolan
    24. January 2011 at 06:39

    “Thus I’d move up to Washington where there is no state income tax.”

    You would be a fool to do so without first checking out what was happening to state services in Washington. Of course, different people in any income bracket use different state services, but I and my neighbors in WA are being asked to pay more for services that were previously state financed. I’m not altogether against this, by the way, some of those state services should not have been taxpayer financed in the first place. My point is, don’t think you would realize dollar-for-dollar savings by moving to low-tax Washington. And don’t forget, Washington’s low taxes are capitalized into home values here, so that might be another surprise.

  25. Gravatar of scott sumner scott sumner
    24. January 2011 at 09:32

    Jim, You said;

    “I thought part of Keynsianism is for gov’ts to deficit spend during recessions and anti-deficit spend (run surpluses) during good times.”

    No, that sort of old Keynesianism was discredited in the 1980s. New Keynesianism say monetary policy should be used to stabilize the economy.

    Ed Dolan, It doesn’t matter if I had to pay just as much. I hate income taxes. It makes me miserable filling out all the forms. I’d even pay more to avoid income taxes.

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