Wage targeting to NGDP targeting

People often ask me for a mathematical model illustrating my views.  I’m not a fan of such models, but I do understand their appeal to others.  In any case, it’s not something I do, but I would encourage younger economists to take a stab at it. Here I’ll suggest one possible path.

We already have models showing that the central bank should target the stickiest prices.  For instance, here’s Mankiw and Reis (2003):

This paper assumes that a central bank commits itself to maintaining an inflation target and then asks what measure of the inflation rate the central bank should use if it wants to maximize economic stability. The paper first formalizes this problem and examines its microeconomic foundations. It then shows how the weight of a sector in the stability price index depends on the sector’s characteristics, including size, cyclical sensitivity, sluggishness of price adjustment, and magnitude of sectoral shocks. When a numerical illustration of the problem is calibrated to U.S. data, one tentative conclusion is that a central bank that wants to achieve maximum stability of economic activity should use a price index that gives substantial weight to the level of nominal wages.

I made this argument in 1995, but without a rigorous model.

So how do we get from wage targeting to NGDP targeting?  One problem with targeting nominal wages is that they respond to monetary policy with a lag, because they are fairly sticky.  I’m not sure if this would be a big problem under level targeting, but just to play it safe it might be wise to make sure the wage target addressed the problem of policy lags.

One approach would be to target expected future wages.  Earl Thompson (an under-appreciated genius, who taught David Glasner) got here first, with a sort of wage futures targeting standardproposed back in 1982.  Unfortunately Thompson passed away a few years ago, but his paper is still on the internet, and still being ignored by the profession.  Maybe in about 50 years they’ll catch up to him.

Until then, how can we overcome the policy lag problem if we don’t have a wage futures market?  One approach would be to target total nominal labor compensation.  Suppose there is a negative demand shock, which will eventually reduce nominal wages, or at least nominal wage growth.  But initially there is little or no impact, because of the stickiness of nominal wages.  In that case, employment would fall before wages, and that’s indeed what we tend to see in the US business cycle.  So by targeting total nominal labor compensation, the Fed could indirectly be targeting nominal hourly wages.  Shifts in employment would be a sort of leading indicator of changes in nominal wages.

What could go wrong?  Let’s suppose employment fell for reasons other than sticky wages, in other words the fall in total nominal labor compensation did not presage a fall in hourly wages.  And let’s suppose that the Fed tried to prevent total compensation for falling.  In that case, the Fed would end up pushing nominal hourly wages slightly higher, as hours worked fell.  But hours worked would decline by less than if nominal wages had been held steady.  The bottom line is that an attempt to maintain stable total compensation, if it were unwise from an hourly wage targeting perspective, would lead to a monetary policy that was slightly more countercyclical that desired.  Surely there are worse things in the world than a slightly too countercyclical monetary policy!

I like to think of potential monetary policy rules from a “robustness” perspective. As in “What’s the worst that could happen?”  With the gold standard, some pretty bad things are easy to envision, after all, the real value of gold has been highly unstable in recent decades.  That’s not to say those really bad things would happen, imposition of a gold standard might substantially reduce the volatility of real gold values, but at least one can envision a really bad outcome.  It’s a possibility.

I’d say the same thing regarding money supply rules.  They might work well, but you can envision a big velocity shock.  As far as price level targeting is concerned, you can envision a supply shock that called for a large reduction in real wages, and price level targeting preventing that from occurring in the short run.  I’m not sure that this would be a particularly significant drawback of price level targeting, but it might be.

But with NGDP targeting, it’s hard for me to envision a plausible outcome that is obviously undesirable.  Many people are confused on this point, mentioning the possibility of 5% inflation 0% growth, or 0% inflation and 5% growth.  Yes, the first of these seems undesirable, but the bad outcome doesn’t have any clear relationship to monetary policy failure.  If we had 5% inflation and 0% growth, it would not be obvious whether money was too easy or too tight, even in retrospect. (Many commenters think a monetary policy failure is “obvious” in this case, but can’t agree whether money is too easy or too tight!!  QED.)

A robust policy is one where it’s hard to envision a major policy failure—and by that criterion NGDP targeting seems like a really robust policy.  But total nominal labor compensation targeting seems even slightly more robust than NGDP targeting, because in commodity dependent economies one could imagine a sudden divergence between NGDP growth and total nominal labor compensation growth. And if they diverged, it seems like targeting total compensation would better stabilize the real economy than stabilizing NGDP.

Economics is all about tradeoffs.  The mathematical model I envision would start from the Mankiw-Reis model, but add in a policy lag problem, to justify targeting total labor compensation. As usual, there would be costs and benefits to this approach, and in a prefect information world we could probably do even better, a target that did not necessarily give equal weights to wage growth and hours worked growth.  I suppose you could add that to the model.  But in the imperfect world we actually live in, it seems like stabilizing growth in total nominal labor compensation is going to be pretty close to optimal.  It’s hard to imagine a scenario where that variable is stabilized at 4%/year growth (gradually adjusted over time to reflect changes in labor force growth), and people say, ex post, “policy was obviously too easy” or “obviously too tight”.  What data could they possibly point to, in order to make that claim?



31 Responses to “Wage targeting to NGDP targeting”

  1. Gravatar of Doug M Doug M
    25. November 2015 at 09:17

    From a fiscal policy point of view, should we be encouraging variable compensation?

    It is common in Financial Services, and tech, but over the last 15 years, declining. The tax code and financial reporting standards have been discouraging the use of options and other variable comp schemes.

    This would create a different sort of stabilizer, wages automatically adjust with the health of the economy.

  2. Gravatar of Jerry Brown Jerry Brown
    25. November 2015 at 10:08

    Nice post Professor. Thanks for explaining a little more about TNLC targeting. The countercyclical nature of this policy is very appealing. I know you said that monetary policy doesn’t effect real wages, but doesn’t a policy that promotes close to full employment and lets inflation vary countercyclically, (compared to policy that only targets a low rate of inflation) at least provide the opportunity to increase real wages?

  3. Gravatar of ssumner ssumner
    25. November 2015 at 10:17

    Doug, I doubt there is much the government can do to make wages more flexible, except eliminate minimum wage laws. The best policy is to make sure the monetary policy regime is optimal in a world of sticky wages.

    Jerry, In the long run, monetary policy doesn’t affect either employment or real wages, or any other real variables. I don’t want to see us ask more of monetary policy than it can deliver.

  4. Gravatar of Randomize Randomize
    25. November 2015 at 10:17

    Good post. I would argue that the “bad” scenario for NGDP targets of 0% growth and 5% inflation is actually pretty good in relative terms. Where 0% growth would normally mean rising unemployment, people losing their houses, etc., incomes would instead remain on trend. Yes, real purchasing power per capita would fall (0% growth vs. rising population) but all those sticky nominal expenses like mortgages and car payments would fall as a percentage of income as expected. In other words, we’d all be far, far better off than we were under the current policy regime during the last recession.

  5. Gravatar of Kevin Erdmann Kevin Erdmann
    25. November 2015 at 10:26

    Scott, I agree that most wage stickiness is cultural or permanent, but I think Doug might be on to something. In fact, this seems like another point in favor of eliminating corporate taxation. That would be a strong incentive for firms to base more compensation on profit sharing, options, etc. That sort of tax consequence was enough to ruin the health care market by incentivizing employers to provide insurance in kind, I don’t see why the incentives wouldn’t also be strong enough to lead them to do something useful.

    Now the tax code is set up in many ways to incentivize us away from positions that hold cyclical risk. Reversing that posture might lead to surprisingly deep and positive results.

  6. Gravatar of Jerry Brown Jerry Brown
    25. November 2015 at 10:27

    Doug M, wouldn’t a variable compensation policy be pro-cyclical? As in the opposite of a stabilizer?

  7. Gravatar of Jerry Brown Jerry Brown
    25. November 2015 at 10:37

    Ok, I see Kevin Erdmann’s comment. It could be countercyclical from a firm’s point of view.

  8. Gravatar of bill bill
    25. November 2015 at 14:05

    I posit that if in two similar societies (universes), one started running an optimal monetary policy and the other consistently go it wrong, that over the long run, real wages would end up higher in the society with optimal monetary policy. That over time, optimal monetary policy would allow for greater entrepreneurship and innovations. That in the society with bad monetary policy, more resources would be wasted on foreclosures, litigation over dismissals and things like that. Bad monetary policy can only be dismissed as having temporary bad effects if the instances of bad policy are few and far between. It’s a judgment call as to how long a non-optimal policy has to last before the real effects become permanent.

  9. Gravatar of TravisV TravisV
    25. November 2015 at 14:24

    Jonathan Haidt: The Yale Problem Begins in High School


  10. Gravatar of Kevin Erdmann Kevin Erdmann
    25. November 2015 at 14:31

    That Haidt story is pretty crazy, Travis. There are no liberals any more, just 2 flavors of reactionaries.

  11. Gravatar of TravisV TravisV
    25. November 2015 at 14:58

    New posts by Bob Murphy on market monetarism:



  12. Gravatar of Dan W. Dan W.
    25. November 2015 at 15:19


    You assert that wages are sticky and then you assert that NGDP manipulation via monetary inflation is not. So you recognize that prices will rise faster than will incomes and consequently the standard of living for the common worker is worsened.

    Can you see this undesirable outcome now?

    “But with NGDP targeting, it’s hard for me to envision a plausible outcome that is obviously undesirable.”

  13. Gravatar of TravisV TravisV
    25. November 2015 at 15:30

    Sincere question. I think Ted Cruz is much much much much worse than Donald Trump. Is there ANYONE within the mainstream making this crucial point? Bueller????

  14. Gravatar of TravisV TravisV
    25. November 2015 at 15:48

    I’m really frustrated by this analysis by Scott Lemieux, because it ignores how disastrous a Ted Cruz presidency might be due to tight money.


    “In the likely event that the race ultimately settles into Cruz against Rubio, I think the typical assumption will be that liberals should be rooting for the latter. I completely disagree. Ideologically, there isn’t a Confederate nickel’s worth of difference between them. Erik is right that the stakes of the Democratic Party are a lot lower than you think, but the stakes of the Republican nomination are even lower unless Trump shows more staying power than I think he will. The salient differences between Rubio and Cruz are that the former 1)is better at saying the loud parts quiet, 2)will be a more attractive general election candidate, and 3)can probably work more effectively with Congress. Any major party candidate can win a general election under the right circumstances, but Cruz would make a Republican win marginally less likely, perhaps significantly. He won’t be able to sell it; he’s not respected. Democrats are better off with Ted. Definitely.”

  15. Gravatar of TravisV TravisV
    25. November 2015 at 15:49

    Don Boudreaux vs. Noah Smith:



  16. Gravatar of Benjamin Cole Benjamin Cole
    25. November 2015 at 15:51

    Does an IT band get to the flexibility needed, as opposed to an IT? BTW, there is no law a band has to be 1% wide. The Fed could have a target of 1.5% to 4%. Why such a big band?

    Because minor inflation is not important. Robust real growth is the goal of macroeconomic policy.

  17. Gravatar of Don Geddis Don Geddis
    25. November 2015 at 17:12

    @Dan W: “prices will rise faster than will incomes

    For unexpected monetary inflation, perhaps. For expected, on trend, stable inflation … not so much.

    The point of “NGDP manipulation”, is to keep spending (and thus total income) on the expected trend line. Sticky wages will fail to change quickly to off-trend spending/income; but they will be adapted to whatever the trend line is. It is deviations from the trend line (especially negative nominal demand/income shocks) that cause macroeconomic damage.

    With a smooth, consistent, predictable inflation (or NGDP) trend — such as during the Great Moderation — it is not at all true that the average worker sees a decline in the real standard of living. That’s just false.

  18. Gravatar of Major.Freedom Major.Freedom
    25. November 2015 at 17:30

    “Economics is all about tradeoffs.”

    And in your case the only people whose choices and tradeoffs matter are those made by the government.

    It isn’t economics you’re doing, it’s political strategizing about how to best maintain aggression backed power structures in society. No more, no less.

    Actual economists study trade offs of individuals as such, not special interest groups.

  19. Gravatar of Dan W. Dan W.
    25. November 2015 at 19:01

    You are wrong Major. For we have learned this week that the principles of Econ 101 do not apply in aggregate. The minimum wage can be increased and, even if it disadvantages individual workers, in aggregate it will boost prosperity. And the same for inflation. For while many may see inflation erode their savings and their earning power their plight ought to be ignored. Instead we most focus on aggregate demand and if nominal spending increases then we can claim society is better off.

    The monetarism Scott preaches is just a repeat of the Utopian philosophies of the 19th century which were all just forms of Socialism. By preaching NGDP Sumner wishes away the Law of Economic Scarcity and the Law of Opportunity Cost. In his religion the fundamentals of Economics are nuisances that only apply to those with limited imagination. In its place he erects the god of aggregate spending and claims that as long as this metric is increasing then all is well, no matter the economic burden people actually experience. For such burdened people do not matter. They are unpersons and shall be ignored. Scott will ignore them. For as he wrote such harmed people do not exist. The tautology takes care of that and there shall be no further inquire on the matter!

  20. Gravatar of Ray Lopez Ray Lopez
    25. November 2015 at 19:49

    @Sumner – George Selgin, the free banking advocate (who’s main ideas are also adopted I see by the ex-ballplayer and putative unrecognized genius E. Thompson), endorsed a form of NGDPLT a while ago. Question: can your NGDPLT system co-exist with free banking? Why or why not?

    @Dan W- Sumner is harmless, since money is largely neutral. Only if people panic could hyperinflation occur, if they lose faith in the banking system, but history has shown hyperinflation usually is a result of a dysfunctional economy, such as a wartime economy. Further, Sumner’s proposals are unlikely to be ever adopted (more likely to be is Sumner’s competitor, J. Taylor, who has Republican backing). So relax.

  21. Gravatar of Scott Sumner Scott Sumner
    25. November 2015 at 20:28

    Kevin, I’m certainly all for eliminating the corporate income tax. And perhaps there is more possibility of making wages flexible than I had assumed. But I would still argue that it’s much easier to fix monetary policy.

    Bill, Perhaps I gave the wrong impression. The Great Depression was really bad, and it led to WWII, which was far worse. So please don’t read my comments as minimizing the real damage done by bad monetary policy. On the other hand, by the 1950s real wages were probably about where they would have been with good monetary policy in the 1930s and 1940s, in my view. There is of course lots of uncertainty here, all sorts of “path dependence” questions that are hard to resolve. So I may well be wrong in assuming long run neutrality.

    Dan, You said:

    “You assert that wages are sticky and then you assert that NGDP manipulation via monetary inflation is not. So you recognize that prices will rise faster than will incomes and consequently the standard of living for the common worker is worsened.”

    I don’t even know what that means. When did I asset that monetary manipulation is not sticky? What does that mean? When did I claim that prices will rise faster than incomes? And please, I beg of you, don’t tell me you think wages are “incomes”. Why do you even comment here?

    And I love how you use the term “assert”, as if wage stickiness is somehow controversial.

    Travis, How could someone be worse than Trump? He’d still be the worst candidate in American history if he endorsed NGDPLT tomorrow.

  22. Gravatar of Scott Sumner Scott Sumner
    25. November 2015 at 20:29

    Ray, I love how you think the Republicans can somehow influence monetary policy.

    Yes, of course free banking can coexist.

  23. Gravatar of TravisV TravisV
    25. November 2015 at 21:04

    Dear commenters,

    Do you agree with Prof. Sumner that a President Trump scenario would turn out worse than a President Cruz scenario?

    Seems wrong to me……

  24. Gravatar of Thanksgiving assorted links Thanksgiving assorted links
    26. November 2015 at 07:17

    […] Robust monetary rules.  And American Airlines stops accepting Argentine […]

  25. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    26. November 2015 at 07:21

    ‘How could someone be worse than Trump?’

    His name is Barack Obama. Who gave us the disaster that is playing out over Obamacare; people discovering that they are paying for health insurance that they may never use, because they won’t hit the deductible amount in their ‘affordable’ plans.

    And, of course, the refugees fleeing Syria are Obama’s fault.

    Trump has faults in abundance, but with his Wharton MBA you could at least talk to him about monetary policy, and he would probably not say that, ‘Monetary policy has shot its wad.’

  26. Gravatar of ssumner ssumner
    26. November 2015 at 08:42

    Travis, I’m saying Trump would be worse than anyone, and I’m including all 320 million Americans. I’m saying he’s the worst of the lot. Since Cruz is one of the other 320 million Americans, obviously he’s less bad than Trump. I’d prefer the random inmate in Supermax prisons to Trump.

  27. Gravatar of Ray Lopez Ray Lopez
    26. November 2015 at 09:11

    Sumner: “Ray, I love how you think the Republicans can somehow influence monetary policy. ” – but they are leading the charge over auditing the Fed, asking the Fed to explain its monetary policy? I think even a bill passed along those lines recently… yes, “Fed Oversight Reform and Modernization Act” (FORM)… what are your views on FORM? Also a post on how free banking could coexist with NGDPLT is welcome. Would free banks have the power to mint money?

    TavisV: “Do you agree with Prof. Sumner that a President Trump scenario would turn out worse than a President Cruz scenario?” -Yes, that’s easy. Trump is a troll and bankrupt. You might as well make me president, at least I’m not bankrupt.

  28. Gravatar of Larry Larry
    27. November 2015 at 22:36

    Been reading a lot about rising healthcare costs. Given that health care is highly Inelastic (given the widespread blank checks written by government) are we overestimating Inflation?

  29. Gravatar of ssumner ssumner
    28. November 2015 at 13:04

    Larry, There is no perfect measure of inflation, it’s just a matter of opinion.

  30. Gravatar of Ray Lopez Ray Lopez
    28. November 2015 at 19:36

    @Sumner: (commenting on Dan W.’s remark):

    I don’t even know what that means. When did I asset that monetary manipulation is not sticky? What does that mean? When did I claim that prices will rise faster than incomes? And please, I beg of you, don’t tell me you think wages are “incomes”. Why do you even comment here?

    Contrast your reply above with Don Geddis’ reply to Dan W. Geddis understood Dan’s question and answered it succinctly. His answer made perfect sense, even though I disagree with it. Your answer feigned confusion (or maybe it was not a feign, and you’re just confused). Then you wonder why your readers hate your attitude. The Rush Limbaugh of monetarism, or, like your Finnish computer programmer counterpart, the Linus Trovalds of monetarism (“Linus Torvalds is known for angrily disagreeing with other developers on the Linux kernel mailing list. [43] Calling himself a “really unpleasant person”).

  31. Gravatar of George Selgin George Selgin
    19. May 2017 at 13:28

    “We already have models showing that the central bank should target the stickiest prices.”

    The argument is quite old, in fact. Gunnar Myrdal makes much of it in his ca. 1934 book on “Monetary Equilibrium.”

    The real merit of mathematical models is that, so long as one can come up with new and fancier approaches to such, while studiously avoiding knowledge of the history of thought) one can make a career reinventing the wheel.

    In fact the argument is very intuitive, and all the math is overkill.

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