Wage cuts
A decision by the Fed to cut its interest rate target is usually expansionary.
Falling market interest rates are usually a bad sign, an indication that money is too tight, and getting tighter.
A decision by a firm to cut wages is usually expansionary for employment.
Falling aggregate wage rates are usually a bearish indicator, a sign that money is too tight.
Most people have trouble wrapping their mind around these seeming contradictions.
The recent surge in unemployment has caused massive distortions in the labor market. Due to “composition effects” we don’t have good data on aggregate wage changes for a given skill level. (Average hourly wages are rising, but only because it’s mostly the lowest skilled workers who are losing jobs.) Nonetheless, Bloomberg suggests there is strong anecdotal evidence of falling wage rates in a number of firms:
Companies across the U.S. are cutting salaries as they fight to survive the coronavirus, upending a key assumption in modern economics and raising another hurdle to rapid recovery.
The hard numbers won’t be in for months, but anecdotal evidence is piling up. On earnings calls, big businesses including The Container Store Group and Lyft have cited what they say are temporary salary reductions. Federal Reserve officials also have found plenty of supporting evidence.
As is often the case with wage cuts, people wrongly assume that this phenomenon contradicts sticky wage models:
That’s not supposed to happen, according to ideas that have dominated economics for the better part of a century, since John Maynard Keynes unveiled his famous “General Theory” during the Great Depression.
The phenomenon is known as “sticky wages.” Employers may be able to cut inflation-adjusted pay by raising wages less than prices, the argument goes. But it’s harder to cut pay in nominal terms — in other words, by putting a smaller number on people’s paychecks.
That’s why supply and demand get out of balance in a slump, according to the so-called New Keynesian model that Fed officials and other policy makers lean on.
There may be some economists who are so ignorant of history that they don’t know about nominal wage cuts, but most of us are aware of the phenomenon.
Sticky wage models predict that hourly nominal wage rates will fall much less sharply than NGDP during a slump. And that’s exactly what’s happening right now.
As an aside, I don’t believe the sticky wage model is particularly helpful in explaining the recent slump in the economy (which is primarily due to a real shock), but I do fear that the model will be useful next year, at least if NGDP is still depressed.
To find declines in NGDP comparable to the second quarter of 2020 you need to go back to the early 1920s or the 1930s. And nominal wages also fell on those occasions. There’s nothing new under the sun.
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27. May 2020 at 11:25
If the money is too tight, wouldn’t banks raise the interest rate to attract more deposit? So how is a falling interest rate contractionary?
In a related note, I’ve been checking OECD data on employment rate and labor force participation rate:
https://data.oecd.org/emp/employment-rate.htm
https://data.oecd.org/emp/labour-force-participation-rate.htm
It’s interesting to note that Switzerland has a high employment rate while having the lowest inflation rate:
https://data.oecd.org/price/inflation-cpi.htm
Why aren’t the wages sticky in Switzerland? What’s their secret sauce? As someone living in France, I want to borrow some of that.
27. May 2020 at 11:45
Do you think it’s inflexible debt (unit of account) not prices/wages that causes nominal shocks to affect the real economy via unemployment/deflation? In theory a non-unionized company could cut wages/prices on a whim, but they can’t shed debt without going through the bankruptcy process, which has its own frictions.
27. May 2020 at 12:11
Wouldn’t a firm cutting wages be contractionary for employment?
27. May 2020 at 12:46
How do you think about this in the context of what seems to be a complete lack of labor bargaining power? Yes, monetary policy can bring down real wages in hopes of increasing employment. However, the equity market is telling us that this decline in real wages is falling directly into corporate profits…thus pushing the profit share of GDP from a record high to an even higher record high. Is this economically and/or politically sustainable?
27. May 2020 at 12:58
@Effem: Agreed, this is something I think about too. It seems so many of the problems in the US stem from this, with labor especially low skilled labor getting a smaller and smaller share of GDP, resulting in the despair of the white working class and then Trump.
Shouldn’t the pendulum swing back to where labor benefits a bit more from growth and not just capital?
27. May 2020 at 14:05
Kevin, No, it’s definitely sticky wages. Nominal debt burdens are a sunk cost, and don’t have much effect on employment.
Shyam, No, wage cutting is often an alternative to layoffs.
Effem, I see no evidence of a complete lack of bargaining power. Wages have been growing at 3%/year prior to the pandemic.
msgkings, Net corporate profits are only 7.6% of GDP.
You said:
“resulting in the despair of the white working class and then Trump.”
I doubt whether Trump was caused by the “despair” of the white working class. He ran on a platform of huge tax cuts for corporations, and that was the only important promise he delivered on.
27. May 2020 at 14:28
I’ll take a stab at trying to wrap my head around the paradoxes. First let me number your examples:
My explanations:
1. The major supplier of credit is opting to make the price of credit more attractive to buyers of credit. This is an event that will cause a state change.
2. The cost of credit is too high as indicated by the suppliers of credit having to drop their prices. This is an observation of the state of a system.
3. A consumer in the labor market has decided to shop for cheaper labor components, so the consumer will be able to buy more components. This is an event that will cause a state change.
4. The price of labor is too high relative to the cost of labor and that labor cost includes the credit necessary to invest in more labor. This is an observation of the state of the system.
27. May 2020 at 14:58
It’s probably too extreme to say labor has a complete lack of bargaining power. But you can’t deny that the labor share relative to the profit share is at or near record lows. Larry Summers spends a lot of time on this in his latest paper and concludes its most likely the result of a lack of bargaining power.
27. May 2020 at 15:15
I think I agree with this post.
BTW, Singapore is spending heavily to keep workers on private payrolls, 15% national budget deficit to GDP in fy 2020, but perhaps more as suuplemental budgets are enacted. But they are not borrowing, they are spending from reserves.
Singapore has a lot of reserves; it is national policy to run trade surpluses.
Singapore is in deflation now.
27. May 2020 at 15:31
Scott,
good post.
And everbody sees it that way and is completely rational about it? Maybe it’s psychological, and even similar to wages. People do worry a lot about debt.
27. May 2020 at 15:41
Effem, But the lost wages are not going to corporate profits, which are lower than in the 1960s. It is going to depreciation and also to implicit rent on owner-occupied homes.
27. May 2020 at 17:29
Effem, But the lost wages are not going to corporate profits, which are lower than in the 1960s.—-Scott Sumner
Huh?
https://fred.stlouisfed.org/series/CPATAX
https://fred.stlouisfed.org/series/W273RE1A156NBEA
With globalization, measuring profits may become more of a guessing game….
The first series suggests a huge explosion of corporate profits in the last 60 years, and the second that profits are roughly the same in relation to domestic income along the decades….
If the S&P 500 is a rough measure of corporate profits, then profits are doing great, much higher than in the 1960s….
27. May 2020 at 17:52
OT, but in the blog-park—-
https://markets.businessinsider.com/news/stocks/federal-reserve-yield-curve-control-coronavirus-economy-recession-stimulus-relief-2020-5-1029238847
The Fed may target yields…same as the Bank of Japan, which pegs interest on 10-year JGBs at 0.10%.
27. May 2020 at 18:32
@ssumner:
Come on dude, the corporate rich guy tax cut voter isn’t why he won (although they mostly vote Republican anyway). He won because he clobbered Clinton with the non-college educated male vote, which was decisive (barely) in 3 electorally advantageous states. He won because that demographic wanted to send a big f-u to the ‘coastal elites’.
And I do still believe capital has been taking a larger and larger share of GDP vs labor. I’m not all Piketty about it, but it is a real thing that is happening.
27. May 2020 at 19:16
> Companies across the U.S. are cutting salaries as they fight to survive the coronavirus, upending a key assumption in modern economics and raising another hurdle to rapid recovery.
Why does the Bloomberg article say that falling wages would be a hurdle to a rapid recovery?
They are somewhat aware of sticky wage assumptions, but they pretend here that flexible wages are a problem?
28. May 2020 at 00:06
‘2. Falling market interest rates are usually a bad sign, an indication that money is too tight, and getting tighter.’
Doesn’t this get one into ‘never reason from a price change’ territory?
28. May 2020 at 05:44
msgkings,
Blame the Fed for much of the plight of poorer workers over the past generation. Tight money disproportionately affects less poorer workers, as they are the first laid off on recessions, and the last hired, on average, during our increasingly long, weak, and incomplete recoveries.
The stock market has also suffered, believe it or not. Stock prices would be higher with better monetary policy. In fact, capital investment suffers disportionately from tight money, being mostly responsible for our low productivity growth since the mid-2000s.
28. May 2020 at 05:49
Poorer, not “less poorer”.
28. May 2020 at 07:38
Was taking my profit data from the following…might be worth a read:
How the Wealth was Won: Factor Shares as Market Fundamentals (Updated Apr, 2020; Barron’s)
with Martin Lettau and Sydney C. Ludvigson
Abstract: Why do stocks rise and fall? From the beginning of 1989 to the end of 2017, $34 trillion of real equity wealth (2017:Q4 dollars) was created by the U.S. corporate sector. We estimate that 43% of this increase was attributable to a reallocation of rewards to shareholders in a decelerating economy, virtually all of which came at the expense of labor compensation. Economic growth accounted for just 25%, followed by a lower risk premium (24%), and lower interest rates (8%). From 1952 to 1988 less than half as much wealth was created, but economic growth accounted for more than 100% of it.
28. May 2020 at 07:44
“Falling market interest rates are usually a bad sign, an indication that money is too tight, and getting tighter.”
Intuitively, I’d expect tight money to lead to higher natural rates of interest. When there is very little money to go around I only invest in the most profitable projects. Alternatively, when money is everywhere the lucrative projects get bid up to the point I have to accept lower yields. What am I missing here?
28. May 2020 at 10:11
msgkings, Yes, but why assume it was for economic reasons? Maybe they disliked the culture of coastal elites. Immigration. Political correctness. Abortion. People vote for all sorts of reasons. Some voters liked his race baiting.
Tacitus, No, because I said “usually”. I.e. it can represent easy or tight money, but it’s usually tight money.
Effem, Yes, but I don’t trust those studies. For every such study you can find another with radically different assumptions and radically different results. I suspect that lower rates and lower risk premiums are the main reason for higher stock prices.
That’s not to say that corporate profits are not too high–I’d prefer we weaken intellectual property rights–but it’s not the main problem with our economy. The main problem is horrific waste in health care, education, and many other sectors due to bad regulations. That’s what lowers living standards.
Net corporate profits are 7.6% of GDP, while there’s more than 7.6% of GDP wasted in just healthcare.
Trying to learn, Tight money leads to slower NGDP growth, and slower NGDP growth leads to lower interest rates.
28. May 2020 at 10:56
@ssumner: That’s fair. But I find it hard to believe the economic decline of the (white) working class wasn’t a big factor too. Immigration in particular is seen by these folks as an economic threat.
28. May 2020 at 17:04
ah, sumner channeling the artful dodger in this post: “i said usually”; “tight money leads to lower ngdp and thus lower interest”(seeing cause and effect through the irrefutable monetarist panopitcon addled by non-neutrality of money); sticky wages must never be allowed a purchase in the wonderful land of ozonomics. woe to the dismal science. is it a priesthood?
28. May 2020 at 18:34
Anna Stansbury, Lawrence H. Summers
NBER Working Paper No. 27193
Issued in May 2020
NBER Program(s):Economic Fluctuations and Growth, International Finance and Macroeconomics, Industrial Organization, Labor Studies
“Rising profitability and market valuations of US businesses, sluggish wage growth and a declining labor share of income, and reduced unemployment and inflation, have defined the macroeconomic environment of the last generation.”
Well, that is how Larry Summers sums it up.
29. May 2020 at 06:19
Normal recessions are difficult enough to analyze, let alone one whose source was not recognizing Covid-deaths are in the right tail of old age. While, we of course were aware this was true, our policies at best were vague as to how best to address this phenomenon. It is a truism that we need to get back to normal.
Scott, who does not believe in irreversible non-linear collapse, probably is more sanguine than many as he has stated that economies have the ability to return to normal quickly once the cause, usually tight money,—-and in this case, also true decline in Covid case growth—-is corrected.
I tend to trust his judgment about economics and monetary policy. Everything else he writes about is just intelligent speculations and helpful for his readers to think.
I write this because I believe the the best action is to end prohibitions, and let the free markets in the broadest sense do what they will do. Unfortunately, opinions do not matter as politicians will do what they will do.
While Scott, as it is his expertise, focuses on policy but tends to give the impression that the politics of the virus is a given. He is likely correct. But I assume he has a view on what we should be doing. But I cannot tell what it is.
If I am guessing I think he supports what I referred to as a “free market “ solution. Of course this is not mutually exclusive from government trying to provide help and good information. But in the end, I am against all prohibitions. But I honestly do not know his views on this.
29. May 2020 at 15:15
@ Prof. Sumner: ‘No, because I said “usually”. I.e. it can represent easy or tight money, but it’s usually tight money.’
Not to be annoying, but what evidence do you have to back this up? And what specific era are you looking at for these data?
If I look at long cycles of history, overall, going back maybe 750 years, I see lower market interest rates correlated with a surplus of capital. That is often followed by poor investment choices and losses which leads to tight money, but I don’t think that’s what point you’re trying to make.
Is this only a recent phenomenon?