The pitfalls of using common sense

Here’s Steve Williamson criticizing the sticky wage model of the recession:

Sticky wages and prices: Come on. The recession began in fourth quarter 2007, according to the NBER. How can we be suffering the effects of stuck wages and prices in mid-2012? The 1981-82 recession occurred in the midst of a rapid disinflation, from close to 15% (CPI inflation) in early 1980 to 2.5%, post-recession. If there was a time when wage and price stickiness would matter, that would be it. But, as you can see from the last two charts, the 1981-82 recession was short compared to the recent one, with a robust recovery.

I have a lot of problems with this, starting with his appeal to common sense.  His preferred theory is that a loss of wealth has depressed output.  I could just as well ask “Come on, a big loss in wealth in 2008 is supposed to be causing people to prefer to work less in 2012?”  Indeed I don’t really even understand the argument, as I would think  a loss of wealth would make people work harder.

My second complaint is that I do not believe that that a drop in AD in 2008 is depressing employment today.  I think we’ve fully recovered from that shock.  It’s the even bigger drop in AD in 2009 that I think is still depressing output.

My third complaint is that wage stickiness is a much bigger problem when inflation is low, not high.  In 1982 all employers had to do to restore labor market equilibrium was grant smaller pay increases.  In contrast, consider the following example from George Selgin:

Here at UGA we haven’t had any raises for five years running. I know professors elsewhere with similar experiences.

I presume he means that the pay increase during each of those 5 years was zero.  Now let’s analyze that pattern from Williamson’s perspective.  Presumably he doesn’t think wages are sticky after new contracts have been issued.  So each year the UGA  administration sat down and discussed all the possible pay increases they could grant.  How about 2%?  How about 0.5%?  How about negative 1%?  And so on and so on.  Then it just so happens they decided on 0%?  What a coincidence!  The odds must be 10 to 1 against that particular number.  And then the next year it was zero again!  And the next year.  Now you are talking a 1000 to 1 shot.  And the next.  And the next.  Amazing coincidence?  Or money illusion?  I think you know where I stand, just from the title of this blog.  I don’t know why people have money illusion, and it’s certainly a bizarre thing to put into a model.  But it’s there.

I seem to recall that Steve Williamson shares my preference for rational expectations models and the EMH.  Money illusion is one of my few concessions to the behavioral economists.  I wish it weren’t there—it makes our models much uglier and it causes enormous human suffering.  But wishing it weren’t there doesn’t make it go away. “The world is as it is.”  Between mid-2008 and mid-2009, NGDP fell about 9% below trend, while wages kept chugging along at roughly trend.  That’s a really big problem.  Although unemployment has since fallen from 10% to 8.2%, wages still haven’t entirely caught up to that massive demand shock.

There’s another problem with using common sense.  The real world is very complex, and no one model can explain everything.  Obviously the 40% increase in the minimum wage right before the recession slowed the downward adjustment in wages, especially for the lower classes where unemployment is concentrated.  People typically ridicule the minimum wage hypothesis by saying “Come on, that can’t explain all the unemployment.”  True, but no one claims it can.  Ditto for the extended UI benefits.  The natural rate of unemployment is estimated to be 5.6%, the actual rate is 2.6% higher.  That extra 2.6% is partly extended UI benefits, partly the big minimum wage increase, and partly sectoral reallocation of labor.  But I believe it is mostly wage stickiness, and the stock market also seems to think more NGDP would help a lot right now.

The W/NGDP ratio shot up in 2009, and unemployment soared.  Since then the ratio has come part way back to trend, and the unemployment rate has come part way back to trend.  We have excellent data showing George Selgin’s example is common, wage increases bunch around zero percent.  Until we get a more plausible theory of unemployment, I’m sticking with stickiness.


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59 Responses to “The pitfalls of using common sense”

  1. Gravatar of Lorenzo from Oz Lorenzo from Oz
    15. July 2012 at 06:25

    Nominal stickiness has a long history. In James C Scott’s “Seeing Like a State” (excellent book, btw) he has a discussion of feudal lords shortening or lengthening measures so as to squeeze more out of the peasants. For example paying wages in smaller baskets than those used for collect dues in. The contractual obligations remained nominally constant while the real value changed. On estimate is that the size of bushel (boisseau) used to collect the main feudal due (taille) increased by a third between 1674 and 1716.

  2. Gravatar of Lorenzo from Oz Lorenzo from Oz
    15. July 2012 at 06:31

    Come to think of it, Scott’s analysis seems somewhat applicable to central banks. Paying attention to others’s experience, having effective avenues of feedback, not going for reassuring but distorting simplicities …

  3. Gravatar of dwb dwb
    15. July 2012 at 06:39

    maybe. as i’ve noted before, mortgages reflect the (past) price of housing, which are very sticky. basic sticky price theory says when prices revert to market, employment rebounds. That is exactly what is happening in NV, AZ, and CA as the foreclosure pipeline drains (see below). It takes a whopping 700+ days for a house in the foreclosure pipeline, which seems at capacity at about 200-250k foreclosures/month. very sticky! clearly we have a long way to go since the three states lost 300k jobs, but the three states ought to be adding a solid number of jobs in construction by middle next year. overall cons employment is still 30% below 2007, but it its slowing clawing back.

    Another test of the sticky price theory is that construction employment should rebound in so-called non judicial states faster (because the foreclosure pipeline is “stickier” in those states). generally that appears to be true.

    wages are only a small part of the price of housing, so i have to agree i don’t see sticky wages alone as the explanation. construction employment will return, maybe 3/4 of the way to 2006 levels, but it will return.

    http://research.stlouisfed.org/fredgraph.png?g=8LQ

  4. Gravatar of George Selgin George Selgin
    15. July 2012 at 06:40

    The point of my example was to suggest that, while one seldom sees absolute reductions in money wage rates in a setting in which people are accustomed to at least some inflation, one does witness non-trivial reductions in money wage growth rates, quite possibly bounded in many cases at zero from below.

    That of course isn’t saying that the deceleration of wage growth ought necessarily to have sufficed to make up for the previous collapse (and later partial recovery) of NGDP–the subject of my recent exchange with Scott.

  5. Gravatar of Morgan Warstler Morgan Warstler
    15. July 2012 at 06:48

    “The world is as it is.”

    ROFL.

    Hegemony is the world as it is.

    November 2012 we find out for sure who’s right.

  6. Gravatar of Steve Steve
    15. July 2012 at 06:51

    STICKY WAGES PLUS HEALTHCARE???

    Consider, someone who earns $45K/year and receives $5K is employer health insurance.

    The next year, the employer freezes the salary at $45K, but health insurance costs rise to $5.5K. The employment cost, from the employers perspective, rises from $50K to $50.5K, thus is sticky at +1% or higher per year.

    I’m not sure how various wage and labor cost indices account for health care and benefits costs, so I don’t know to what extent benefit cost inflation adds to the stickiness problem… Thought?

  7. Gravatar of Zorblog Zorblog
    15. July 2012 at 07:37

    Common sense? Where is the common sense here? It does not matter that inflation decreases, as long as it remains high enough above zero.

    Let’s use common sense another way and start with the assumption that prices and wages are sticky. They may go up, but not down.
    If inflation is nil, it means that there are no price movements at all, which implies that there can’t be any relative price adjustment in the economy. And this raises two questions:
    – are price adjustments desirable? I suppose this is one the few consensus areas among economists.
    – are prices and wages really sticky? Well, this is a question you should not try to answer with a model, but with empirical observations (run a cross-section on Europe over the last ten years, and you might get a conclusive answer)

  8. Gravatar of ssumner ssumner
    15. July 2012 at 08:00

    Lorenzo, That’s a great example.

    George, Yes, I do understand that that was the point of your example, but I decided to use it to make an entirely different point. I agree that your example does show SOME wage adjustments occurring.

    dwb, Just to be clear, the sticky wage model does NOT claim that sticky wages are the cause of unemployment in specific industries, like housing. But only in aggregate.

    Steve, Here’s the way to think about benefits. If they increase faster than wages, then it pushes the equilibrium wage increase closer to the zero bound. That makes wage stickiness worse.

    Zorblog, I’m afraid you lost me there.

  9. Gravatar of Zorblog Zorblog
    15. July 2012 at 08:22

    Scott, my fear is that if I lost you, I might not have been doing much sense.
    Never mind, I try again.

    Take an economy with 10 goods, each with a given price at t=0.
    For whatever reason, none of these prices can decrease, but each of them may increase.
    Now we’re in time t=1, and there was no inflation at all. What can we say about the prices of the 10 goods? We can say that each of the 10 prices remained the same.
    Because if one price had increased, you would need another one to go down to keep the aggregate price level constant. But according to our assumption, it is not possible for a price to go down.

    The conclusion is that if prices and wages are sticky, and the central bank prevents any inflation at all (a bit like the ECB does), then there is no possibility for relative prices to adjust (and it is difficult for the economy to grow or reach full employment).

    I guess this is not very different from what Krugman says when he advocates for inflation in Germany, in order to readjust prices with Southern Europe.

  10. Gravatar of Saturos Saturos
    15. July 2012 at 09:01

    I’ve been waiting for this post for a long time now. If you’re going to present your theories to the profession in blog posts instead of math, then you need one like this.

  11. Gravatar of Greg Ransom Greg Ransom
    15. July 2012 at 09:15

    The sticky wages — actually the INCREASING wages — have been in the government worker sector, where compensation continues to skyrocket against all possibility of sustainability, and where compensation increased are made possible by increasing the number of unemployed government workers.

    Pink slips for the new hires, increases in benefits & wages & retirement pensions for those on the top of the seniority ladder.

    Read the paper.

  12. Gravatar of Greg Ransom Greg Ransom
    15. July 2012 at 09:21

    College administrators at every level in California continue to get MASSIVE compensation increases, often going from the mid- $250,000 range to the mid $350,00 plus additional housing and transportation and other benefits.

    What is happening at UGA is not AT ALL reflective of what is going on in the Blue States.

  13. Gravatar of Greg Ransom Greg Ransom
    15. July 2012 at 09:27

    Field research, field research, field research.

    Time to turn economics into science.

    Biologists do FIELD RESEARCH.

    Economists hang out in the offices and talk to other economists, and pull down the curtains.

    It’s absurd for professors to look at their own personal salary and make inferences about the whole economy.

    And what about your compensation beyond salary — EVERYONE’S health insurance has gone up in the last 5 years, which means that George Selgin’s health insurance compensation has GONE UP.

    Do the math.

  14. Gravatar of ssumner ssumner
    15. July 2012 at 10:23

    Zorblog, Now I see. Technically that may be true, but I wonder how important given that inflation targeting is very imperfect. After all, price stickiness doesn’t mean prices never fall, just that they are slow to adjust. So you could target, say, 12 months forward inflation and still allow some individual prices to adjust up and down.

    But I do get your point.

    Thanks Saturos.

    Greg, Yes, I could have added government wages to the equation.

  15. Gravatar of Wage stickiness is market failure. So why are we not correcting it? | Citizen.Cam. Wage stickiness is market failure. So why are we not correcting it? | Citizen.Cam.
    15. July 2012 at 10:26

    […] Sumner has a gift for inspiring revelation. He says: The W/NGDP ratio shot up in 2009, and unemployment soared. Since then the ratio has come […]

  16. Gravatar of OneEyedMan OneEyedMan
    15. July 2012 at 11:16

    Do tenure contracts even allow the possibility of wage cuts? One reason federal judge salaries cannot be cut in addition to their lifetime tenure is to protect their independence. If you can cut the pay of professors saying unpopular things then tenure isn’t much protection.

  17. Gravatar of Dan Carroll Dan Carroll
    15. July 2012 at 11:30

    In every firm I have worked in and have studied, sticky wages are very real. At the upper income levels, firms have circumvented the problem with bonuses, options, or other variable compensation. Which is a key reason unemployment among high income remains low. That and the fact that fixed labor costs (like healthcare), are a smaller percent of the total. sticky wages are likely reinforced by debt (mortgages), as debt service costs are even stickier.

    The question is whether this the natural state of the world, or one created by decades of positive inflation, as my generation never had zero or negative inflation until 2008. Could the world adapt to a zero inflation environment?

  18. Gravatar of Jeff Graver Jeff Graver
    15. July 2012 at 11:41

    Scott: Between mid-2008 and mid-2009, NGDP fell about 9% below trend, while wages kept chugging along at roughly trend.

    That sentence caught my eye. IIRC, you have suggested in past posts that if you could pick any nominal target for the central bank, you would pick a measure of nominal wages. Am I remembering correctly? If so, does the above sentence suggest that such a target would have performed badly at that time?

  19. Gravatar of Major_Freedom Major_Freedom
    15. July 2012 at 12:24

    Wage stickiness in a free market is no more sticky than inflation raising prices in the other direction.

  20. Gravatar of Greg Ransom Greg Ransom
    15. July 2012 at 13:02

    Inflation as a cure for the power of government unions to set their own compensation level increases — good luck with that ….

    In CA teacher unions run candidate slates with posters in the schools reading “elect your own bosses, vote the slate”.

  21. Gravatar of Major_Freedom Major_Freedom
    15. July 2012 at 13:03

    Between mid-2008 and mid-2009, NGDP fell about 9% below trend, while wages kept chugging along at roughly trend. That’s a really big problem.

    This is given the fact that the government promises inflation.

    If the government didn’t promise inflation, if we lived in a healthy deflationary economy, then existing workers wouldn’t fear accepting wage rate cuts, new workers wouldn’t fear accepting lower wage rates, and employers wouldn’t fear being outcompeted for labor by offering lower wage rates to new workers or cutting wage rates for existing workers. Lower wage rates would be much more open to acceptance.

    Why are market monetarists not addressing the consequences of inflation such as wage rate cut resistance? I know. It’s because inflation cannot be presented as a credible work-around for wage rate “stickiness” if inflation itself is a major reason why wage rates are less flexible than they would be without inflation. Cures can’t be advertised as cures if they contain the very same poison the problems of which the cure is claimed to alleviate.

  22. Gravatar of David Pearson David Pearson
    15. July 2012 at 13:22

    “Between mid-2008 and mid-2009, NGDP fell about 9% below trend, while wages kept chugging along at roughly trend. That’s a really big problem.”

    It seems the thesis is that the Fed should target the normally-stable relationship between W and NGDP. Since that 2008 deviation from trend is, “a really big problem”, can you show how that deviation appeared on a graph of W/NGDP, going back to, say, 1990?

  23. Gravatar of Mark A. Sadowski Mark A. Sadowski
    15. July 2012 at 15:55

    “The W/NGDP ratio shot up in 2009, and unemployment soared. Since then the ratio has come part way back to trend, and the unemployment rate has come part way back to trend.”

    Graphing AHETPI/(NGDP per capita) and plotting it alongside the unemployment rate shows that the two have a rather close correspondence:

    https://research.stlouisfed.org/fred2/graph/?graph_id=81259&category_id=0

    So the solution to unemployment is obviously to raise NGDP which ultimately is the job of the Federal Reserve.

  24. Gravatar of Morgan Warstler Morgan Warstler
    15. July 2012 at 16:46

    “Between mid-2008 and mid-2009, NGDP fell about 9% below trend, while wages kept chugging along at roughly trend. That’s a really big problem.”

    It IS a big problem, and we should have been doing everything we could to DEPRESS WAGES during that time…

    AND under Scott’s NGDPLT – we have done exactly that!

    Starting back around 2000, when we finally got to things running hot in 2006, we would have looked around and said,

    “Let’s gut the public employees, so we can get GDP down and buy ourselves some more good times!”

    It is SAD that the people who call themselves MM, just lament the stickiness of wages without championing, the very powerful, VERY POLITICAL outcome of our chosen religion.

    What is wrong with you people????

  25. Gravatar of Morgan Warstler Morgan Warstler
    15. July 2012 at 16:54

    NO ONE actually disagrees with me, that we wouldn’t see the 22M public employees get treated the way Keynes would have treated them under 4.5% NGDPLT.

    You just don’t want to talk about it.

    It isn’t honest.

    A MM shouldn’t be able to mention Sticky Wages without repeating this basic logic…

    The problem is public employees and when 22M actually start getting PAY CUTS and OUTSOURCED whenever we are running hot, the sticky wage problem in many ways is deeply diluted.

  26. Gravatar of David Pearson David Pearson
    15. July 2012 at 16:54

    Mark,
    Thanks for the graph. A couple of observations:

    -UE is higher now than in 2002, yet we have a lower AHETPI/GDP ratio. We also have a lower ratio than in 1999, the previous trough in UE.

    -If you want to claim there is a trend to the ratio, then we fell well short of the 15yr trend in the mid 1990’s, and yet UE was low.

  27. Gravatar of Mark A. Sadowski Mark A. Sadowski
    15. July 2012 at 17:40

    David,
    Yes, I noticed the longterm downward trend in the ratio myself. Offhand I have no explanation (something to ponder). Obviously I choose the 2005 to present timeframe on purpose.

    P.S. Citizen Cam has updated his post (link above at 10:26) with my graph.

  28. Gravatar of Bill Kelly Bill Kelly
    15. July 2012 at 18:17

    Scott, you refer to “Money Illusion”. I am not sure I know what you mean by the term. Would you please define it, or give me a reference to it. Thank you.
    Bill

  29. Gravatar of Catherine Catherine
    15. July 2012 at 18:48

    Forget sticky wages.

    My school district has sticky raises. True of much of New York state public sector employment, thanks to the Triborough Amendment.

    This year our school board signed a contract with the teachers union providing average raises somewhere in the neighborhood of 4%.

    Under the old contract, raises were averaging somewhere in the neighborhood of…8%, I think.

    The rate of increase has been cut in half, an enormous drop for teachers who bought houses and made other decisions based in the expectation of annual far-above-inflation raises.

    However, under the new contract teachers will continue to receive raises well above inflation while home prices have fallen by at least 20% and it’s highly unlikely the average homeowner is receiving 4% annual raises.

    So:

    * property values down 20%
    * homeowner wages probably stagnant
    * tax cap at 2%
    * union contract: 4%

    We have been laying people off every year since the crash, and unless the town votes to override the cap, we will continue to lay people off.

    Sticky raises = unemployment.

  30. Gravatar of Mike Sax Mike Sax
    15. July 2012 at 19:04

    “November 2012 we find out for sure who’s right.”

    If Mitt Romney doesn’t release his tax returns we don’t have to wait till November to know who it will be.

  31. Gravatar of David Pearson David Pearson
    15. July 2012 at 20:40

    Mark A. Sadowski,

    Another observation: to expect W/NGDP to be stable in a recession is to predict that profits will not contract more than NGDP.

  32. Gravatar of Mike Sax Mike Sax
    16. July 2012 at 03:04

    “November 2012 we find out for sure who’s right.”

    If Mitt Romney doesn’t release his tax returns no need to wait till then to know who it will be.

  33. Gravatar of ssumner ssumner
    16. July 2012 at 03:49

    OneEyedMan, Good question–I don’t know about state universities.

    Dan, Good point.

    Jeff, That’s a good question. It points to one weakness of wage targeting, there is less margin for error. If you do level targeting of wages, then market expectations will help keep NGDP from falling sharply, as you’d need to do that in order for future wages not to fall. But NGDP gives you a more timely signal than wages, that much is clear.

    David, I see that Mark produced a graph. Keep in mind that the sticky wage model does not predict a long term stable relationship between NGDP and W, rather just a close relationship over the business cycle.

    Thanks Mark, That’s helpful.

    Morgan, No, we should not have been trying to suppress W, we should have been trying to raise NGDP.

  34. Gravatar of ssumner ssumner
    16. July 2012 at 04:05

    Catherine, Good example.

  35. Gravatar of Mike Sax Mike Sax
    16. July 2012 at 05:12

    On the question of sticky wages though making the recovery harder, the Wall Street Journal has a front page piece today which seems to contradict this. In China they say that “Wage rises in China May Ease Slowdown”

    I would give the link but can’t access it right now so I’m quoting pg A1 of the front page.

    “Wages are still climbing rapidly in China and many companies are having trouble filling jobs despite the sharp economic slowdown here-evidence of structural shortage in the labor market that may help China adjust to slower growth without political instability and whet consumer appetites for foreign jobs.”

    So this makes it sound like rising wages are mitigating the slowdown.

  36. Gravatar of Morgan Warstler Morgan Warstler
    16. July 2012 at 05:36

    “Morgan, No, we should not have been trying to suppress W, we should have been trying to raise NGDP.”

    Doesn’t matter what you wish will happen, under NGDPLT it WILL happen, and you know it.

  37. Gravatar of Mark A. Sadowski Mark A. Sadowski
    16. July 2012 at 06:41

    Scott,
    I came across this by Robert Solow on sticky prices today:

    “Now here is a peculiar thing. When I was in advanced middle age, I suddenly woke up to the fact that my colleagues in macroeconomics, the ones I most admired, thought that the fundamental problem of macro theory was to understand how nominal events could have real consequences. This is just a way of stating some puzzle or puzzles about the sources for sticky wages and prices. This struck me as peculiar in two ways.

    First of all, when I was even younger, nobody thought this was a puzzle. You only had to look around you to stumble on a hundred different reasons why various prices and factor prices should be much less than perfectly flexible. I once wrote, archly I admit, that the world has its reasons for not being Walrasian. Of course I soon realized that what macroeconomists wanted was a formal account of price stickiness that would fit comfortably into rational, optimizing models. OK, that is a harmless enough activity, especially if it is not taken too seriously. But price and wage stickiness themselves are not a major intellectual puzzle unless you insist on making them one.”

    http://www2.gsb.columbia.edu/faculty/jstiglitz/festschrift/Papers/Stig-Solow.pdf

  38. Gravatar of Wonks Anonymous Wonks Anonymous
    16. July 2012 at 06:49

    Williamson has explicitly forsaken EMH to justify his rejection of the market’s inflation forecast. He says he’s a rare economist who has studied the matter and most people he hears talk about it sound dumb, so he’s smarter than the market.

  39. Gravatar of Jason Odegaard Jason Odegaard
    16. July 2012 at 07:26

    Scott,

    My thoughts have been that wage stickiness especially is partially based on people’s predictions of inflation, but even more so a pride issue. Nobody wants to see their “number” go down.

    I see two examples of this, which are ad-hoc of course, but they are what I saw. In January 2009 my employer was laying off a lot of people – that year, pay conversations saw the 0% increase. However, the following year, 2010, 1-2% increases began to become the norm again.

    And in August of 2010 I changed employers, but found a similar environment. Normal performance is back to anticipating around at least a 1% pay increase built-in. And in late 2008/early 2009 the company did have a round of layoffs, and 0% raises. But the 0% raises caused a lot of complaints among employees (actually an “uproar” from what people around then tell me).

    Note that both of these are private sector businesses.

    So both of these companies have seen wage increases began to creep up to 1-2% again, even as inflation has remained low. Both of them only had a single year of 0% increases, and neither saw pay cuts while/instead of conducting layoffs.

    Wages do indeed seem to be sticky. I see it in my own heart. I also see it in the wage data economists gather from businesses.

  40. Gravatar of Mike Sax Mike Sax
    16. July 2012 at 08:28

    Mark Sadowski, thanks for the link. It’s very interesting

  41. Gravatar of TallDave TallDave
    16. July 2012 at 08:56

    Good points.

    Also, I think one first has to ask “in retrospect, what was our prior output actually worth?” Anyone who’s tried to sell a house built 2005 – 2007 has run into the problem that it’s not actually worth as much as it was counted for in “output” back when it was produced — to paraphrase Tyler, we were not as productive as we thought we were!

  42. Gravatar of TallDave TallDave
    16. July 2012 at 08:58

    If Mitt Romney doesn’t release his tax returns no need to wait till then to know who it will be.

    Ah, the Taxers have replaced the Birthers.

  43. Gravatar of Saturos Saturos
    16. July 2012 at 09:08

    Should have known this post would get a rise out of Bryan Caplan: http://econlog.econlib.org/archives/2012/07/sumners_common.html

  44. Gravatar of Floccina Floccina
    16. July 2012 at 09:16

    I agree with Greg Ransom when he says field research, field research, field research. It seems that much more field research should be done in economics.

    @Major_Freedom
    1. Much of the economy is not so free market. There are bottle necks in licensing that restrict supple not to mention lots of Government jobs. We should work to remove these barriers but in the mean time NGDP targeting could reduce the pain.

    2. Over the last 60 years people have gotten accustomed to inflation. They borrowed based on an assumption of inflation and they pay raises based on an assumption of inflation. This is not the best time to turn this around.

    3. If gold is money and the value of gold rises relative to other goods and services people mine more gold and sell more jewelry shouldn’t the CB mimic this as best it can.

  45. Gravatar of JL JL
    16. July 2012 at 09:22

    Jason,

    I fully agree. I’d even say it’s 100% a matter of pride, or self-worth as I prefer to call it.
    I’m a consultant and I often come in companies with underperforming, overpaid employees.

    But if you tell them the truth – you shatter their self-worth and they will perform even less.
    Moreover, non-sociopathic managers want their employees to like and respect them.
    They see themselves as responsible for the welfare of their team.

    So, I am convinced that because of human psychology NGDP per capita must always increase. Everybody needs a wage increase to be happy, every company needs to show their stock and their sales increased.

    In Lake Wobblegon every company is growing, every person is advancing in their career and everybody is happy.

    I even think a good government should manipulate inflation numbers to keep the people happy.
    I’m thinking: randomly increase and decrease some taxes on consumer goods.

    Sure gas is more expensive, but Cheetos are cheaper, so inflation is obviously not a problem in 2013! (/make Cheetos significant part of CPI).

    2014: Houses and Cheetos are more expensive, but Big Macs are cheaper, so inflation was low in 2014! (/remove Cheetos from CPI, add Big Macs to CPI).

    Imagine how happy we would all be if our wage, our worth, increased above the inflation rate?

  46. Gravatar of ssumner ssumner
    16. July 2012 at 09:50

    Mike, Why would you rely on the WSJ? How would they possibly know the impact of rising wages?

    Mark, That’s a good quote.

    Wonks, I thought his models assumed rationality?

    Jason, Great examples.

    TallDave, Yes, but that explains the fall in RGDP better than the fall in employment.

    Floccina, I believe Alan Blinder did field work on wage/price stickiness.

  47. Gravatar of Jason Odegaard Jason Odegaard
    16. July 2012 at 12:17

    JL,

    I was in complete agreement up until the inflation comment. We shouldn’t go rigging inflation numbers like that. Wage growth may or may not exceed goods and services prices depending on supply-side factors that shouldn’t be obscured.

    And in an environment with inflation, it is easier to grant 0% or 0.5% pay increases, while rewarding other performance with 3% or 4% pay increases. It provides greater flexibility to lower real wages to workers or industries that are less efficient or in declining demand, but does not require drastic nominal pay cuts either.

  48. Gravatar of JL JL
    16. July 2012 at 12:32

    Jason,

    You’re probably right that rigging inflation is not one of my better ideas.

    But in general, I think that keeping people happy should also be a priority and economists should investigate tricks governments could use to make people feel good about their lives.

  49. Gravatar of Major_Freedom Major_Freedom
    16. July 2012 at 14:36

    Floccina:

    1. Much of the economy is not so free market. There are bottle necks in licensing that restrict supple not to mention lots of Government jobs. We should work to remove these barriers but in the mean time NGDP targeting could reduce the pain.

    So what, let’s all join in the calls for continued central banking and more inflation so that we can paper over such problems and pretend they don’t exist?

    2. Over the last 60 years people have gotten accustomed to inflation. They borrowed based on an assumption of inflation and they pay raises based on an assumption of inflation. This is not the best time to turn this around.

    By that logic, it is never the best time to turn it around. In other other words, you just said you don’t want to turn it around ever, and you dressed it up in a seeming open minded weighing of alternatives.

    3. If gold is money and the value of gold rises relative to other goods and services people mine more gold and sell more jewelry shouldn’t the CB mimic this as best it can.

    Shouldn’t we just do the real thing instead? How can merely “mimicking as best as we can” a free market, be in any way a means to actually adopting a free market later on, if ever? I don’t see it. I see the same faith as Marx’s belief that proletarian dictatorship is a “given” historical stage of evolution that will (allegedly) transform into stateless paradise as a matter of historical necessity.

    ————-

    I don’t see why you guys are spending countless hours yammering for change and reform, and yet you balk and change and reform that would have market monetarism become a historical fad that is no longer applicable. Gee, I wonder if incentives has anything to do with this psychological barrier? If humans ever adopted a free market in money, then market monetarists, as well as monetarists in general, and Keynesians too (since persistent deficits would be an impossibility), all their intellectual investments would be for nothing.

    See, I am not afraid of REAL change for the better, because my economics is applicable with or without a central bank, indeed, even with or without a state. I am starting to think this is the reason for the ideological antagonism from intellectuals whose worldviews take state intervention as a “given”.

    It reminds me of pro-slave intellectuals during slave emancipation in the 19th century. They too were yammering on about how it would be a bad idea, that it would lead to starvation, mass rioting, and all sorts of vile crap. They implored everyone to accept slavery “as a given” too, that “there was always” slavery” around the world, that “it isn’t going away any time soon”, etc, etc, etc, so “let’s be pragmatic and harness slavery and ensure that the damage to slaves is “minimized.”

    Every intellectual whose theory implicitly rests on a continuance of the very state intervention they claim they would prefer to abolish, is an opportunist who believes the world won’t function without his ideas of control.

  50. Gravatar of Major_Freedom Major_Freedom
    16. July 2012 at 14:38

    ssumner:

    My second complaint is that I do not believe that that a drop in AD in 2008 is depressing employment today. I think we’ve fully recovered from that shock. It’s the even bigger drop in AD in 2009 that I think is still depressing output.

    How utterly unscientific. Does Sumner believe Geist is revealing himself to him and him only?

  51. Gravatar of Links 16 July: London Olympics Start With 32 Mile Traffic Jam – How to Design Magazines Links 16 July: London Olympics Start With 32 Mile Traffic Jam - How to Design Magazines
    16. July 2012 at 16:09

    […] Scott Sumner on a subject of unemployment: […]

  52. Gravatar of Jim Glass Jim Glass
    16. July 2012 at 18:22

    The W/NGDP ratio shot up in 2009, and unemployment soared. Since then the ratio has come part way back to trend, and the unemployment rate has come part way back to trend.

    Out of curiosity I looked at hourly compensation/total compensation. With “sticky wages” causing a problem one would expect hourly compensation to remain stable or keep rising while total compensation falls due to falling employment.

    This is exactly what is visible, quite starkly. Hourly compensation kept rising in 2008 and onward as total compensation plunged:

    http://research.stlouisfed.org/fredgraph.png?g=8NK

    Going back in time before the start of the chart the pattern continues — in prior recessions hourly compensation also continues to rise while total compensation stalls or falls, though the gap is not nearly as stark. I’m a “sticky wages” believer now.

    There’s maybe a political-economic implication to this too, as to the lack of urgency in so many quarters about boosting growth. If those in the 90% of the work force who are employed are mostly getting their real raises as normal, then the median voter is as well off as usual, feels no need to lobby for more growth, and to the contrary pays no cost for falling for “inflation scare” talk and wanting to make money harder.

    (Of course, the big bankers at the Fed both fall into this “our raises are assured” category personally and may be representing this median voter. Another argument for giving the Fed specific, transparent performance targets and the BoG performance-based pay for hitting them.)

  53. Gravatar of Jason Odegaard Jason Odegaard
    17. July 2012 at 04:59

    See, I am not afraid of REAL change for the better, because my economics is applicable with or without a central bank, indeed, even with or without a state. I am starting to think this is the reason for the ideological antagonism from intellectuals whose worldviews take state intervention as a “given”.

    Major_Freedom, what would be your change for the better?

  54. Gravatar of Doug M Doug M
    17. July 2012 at 07:48

    Facors other than wages that are sticky, and prevent markets from clearing.

    Labor mobility — There is a friction that keeps poeple from moving from a region with high unemploymet to a region with low unemployment.

    Simmilarly, there is a cost to exit a career in an industry sheding jobs to move to one taht is flourishing.

    Debt service is also is stiky cost that can keep companies (and individuals) from addapting to a new economic reality.

  55. Gravatar of Sina Motamedi Sina Motamedi
    17. July 2012 at 16:32

    I’m with you, stickiness is the common sense explanation.

  56. Gravatar of ssumner ssumner
    17. July 2012 at 17:10

    Jim Glass, Good point.

    Doug, Other things rate sticky, but wages are the key.

    Thanks Sina.

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    21. September 2012 at 05:10

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    24. September 2012 at 07:16

    […] priest of market monetarism himself, Scott Sumner. I addressed the plausibility of sticky wages here, and in numerous other posts in reply to Tyler Cowen and George Selgin. I’d also point out that […]

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