Scott Sumner  

Never reason from a price change, even in Japan

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Classical liberalism, the forg... Causation...

Here is The Economist:

IF ABENOMICS means anything, it is the promise of the prime minister, Shinzo Abe, to restore healthy economic growth to Japan and end years of deflation. To that end the central bank, sloughing off its traditional caution, has flooded the economy with money and encouraged the yen to slide. Mr Abe has wooed investors with a resolutely upbeat message about Japan's prospects. As a consequence, the stockmarket is up by three-fifths since Mr Abe came to office in late 2012, and even property prices in Tokyo are rising after years in the doldrums. . . .

On the one hand, the labour market is tight to bursting. That is partly because of strong demand for workers in, for instance, construction. But it is also because the population is shrinking fast. The number of Japanese is predicted to fall from 127m today to under 90m by 2060. Every year the working-age population falls by about 1m. Today unemployment stands at just 3.7% (dream on, Spain).

Yet despite a tight labour market, real wages continue to tumble (see chart). In May they fell by 3.8% compared with a year earlier--the steepest decline in years. That is despite the government's use of moral suasion to get companies to hike basic pay in annual wage negotiations with unions this spring. Officials marched into boardrooms to demand higher pay for workers.
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That reminds me of when the New York Times ran a headline saying prison populations were soaring "despite" a fall in the crime rate. Market monetarists would say there is no "conundrum" to be explained. Tight labor markets do not cause rising wages---the relationship between wages and employment depends on whether the economy is hit by a demand shock or a supply shock.

In this case, the BOJ did some monetary stimulus in 2013. This caused Japanese prices to start rising. Since nominal wages are sticky in the short run, rising prices led to lower real wages. Real GDP rose and unemployment declined.

Of course if you look at the world through Keynesian glasses then this all seems very confusing. Many economists have trouble understanding why prices rose rapidly in the US during 1933, "despite" high unemployment.

It's also important to note that one should not make the opposite error, assuming that low real wages will always be associated with a strong labor market. In 1974, real wages in the US fell due to an adverse supply shock. And the unemployment rate rose sharply.

Never reason from a price (or wage) change. First ask what caused the price to change. Then it will all make sense.


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COMMENTS (18 to date)
RPLong writes:

With apologies to James Taranto: Fox Butterfield, is that you?

brendan writes:

Relatedly, John Hussman thinks government deficits drive profit margins higher. To show this he plots the level of the deficit with change in profit margin 12-24 months out. Presto, high deficits cause high margins w/ a lag. Thus, today's high margins must be due to monster deficits in the last few years.

Of course, an alternative explanation is: recession>high deficit>profit margin recovery 12-24 months later.

Edogg writes:

I know everybody thinks deterrence is the coolest, cleverest thing and that the New York Times is so lame, but there was nothing wrong with that article or headline, except for maybe using the word "paradox" to refer to something apparently contradictory rather than logically impossible.

(Just checked the dictionary. "Paradox" can refer to apparently contradictory facts, not just logical contradictions.)

Of course it's notable if a multiplicative product goes up despite a drop in one of the multiplicative factors. And Fox sensibly points to a policy change (increases in sentences) to explain the apparent contradiction. (This might not be the actual reason. Prof. John Pfaff has written papers pointing to increased willingness of prosecutors to file felony charges as the more important proximate cause of increased incarceration.)

Scott and others, would you honestly say that if you heard the crime rate had fallen, you would expect the incarceration rate to have increased? You would be confident that other things affecting crime were insignificant and that increased incarceration per crime was greater than the inverse of crime as a fraction of previous crime? And that if I asked you, is the greater deterrence coming from more arrests by police officers or more convictions in court, you would be able to respond, "Trick question! It's longer sentences"?

Edogg writes:

By the way, despite my snipping in your and David Henderson's posts, I enjoy all of the blogging by you and your co-bloggers.

Edogg writes:

I was too simplistic when I referred to multiplicative factors and an inverse of a fraction. Change in prison population looks something like:

population*(crime rate)*(admissions per crime) - (prison pop.)*(releases/prison pop.)

Crime is a flow; prison population is a stock.

Lorenzo from Oz writes:

Edogg: Surely there is a widespread expectation that locking up more criminals will lead to less crime. Otherwise, why bother having prisons?

Scott Sumner writes:

Just to be clear, I am not recommending locking up more people---I'd prefer the prison population be reduced. But yes, I believe that in general when you increase prison sentences then crime rates will fall.

The actual correlation between crime rates and prison populations is something I cannot predict. AFAIK, crimes committed in prison don't show up in the data, unless it's murder. But perhaps I'm mistaken.

Edogg, You asked:

"Scott and others, would you honestly say that if you heard the crime rate had fallen, you would expect the incarceration rate to have increased?"

I wouldn't have any idea, that's the point of never reason from a price change. (Or a quantity change.)

Edogg writes:

I wasn't disagreeing with the idea that increasing prison sentences should reduce the crime rate. Unfortunately, the effect is not stronger. If it were more effective, increasing prison sentences would reduce the prison population.

All I'm saying is that usage of the word "despite" doesn't imply that the author doesn't know that prison can affect crime.

"Despite increasing prison sentences, a drop in crime," would be a silly headline. Of course, we would expect the crime rate to fall.

"Despite drop in crime, a increase in inmates," is a sensible headline. A drop in crime would normally result in less inmates.

(Unless the whole population is increasing. Or the prison population is below its steady state. Or guilty convictions per crime have increased. Or less people are exiting the prison population.)

Steve Sailer writes:

Falling imprisonment in the liberal 1960s quickly got the message out that crime pays. Rising imprisonment in the 1980s eventually got the idea through the thick skulls of potential criminals that crime doesn't pay. Here's the Crime Misery Index to show the temporal linkages:

http://isteve.blogspot.com/2005/04/introducing-crime-misery-index.html

Leekiamyourfather writes:

If you look for reductions and increases, then you will see points from which the metric reduced or increased. Where is the analysis?

The lead story seems to be matching up with the data more robustly.

Scott Sumner writes:

Edogg, You said:

"Despite drop in crime, a increase in inmates," is a sensible headline. A drop in crime would normally result in less inmates."

Yes, and an increase in inmates would normally result in a drop in crime.

In any case, I think you'd have to read the entire NYT story to see if they "got it." I doubt they did.

Edogg writes:

Thanks for responses. I promise I'll try to avoid making "getting defensive about the precise interpretation of New York Times articles" a theme of my commenting here. (And maybe I'll comment on economics next time.)

Scott, I read one of those articles. It mentioned deterrence in the context of worrying that mass incarceration was reducing the stigma of prison. So, six of one... At least the author's heard of the concept, but he never quite said that crime may have fell due to increased prison sentences.

I have found John Pfaff's writing on the growth of mass incarceration to be fascinating reading. He wrote some guest posts on the blog, PrawfsBlawg. And here are his downloadable academic papers.

Some interesting points in his work:
-Neither the drug war nor increased prison sentences explain much of the rise in incarceration. Instead, the rise in incarceration is almost entirely driven by the increased willingness of prosecutors to file felony charges.
-While a measure of prison years conditional on crime (I forget exactly how he defined this) is now extremely high in the US compared to other countries, it was actually notably lower than other countries in the 70's (I forget the details of this time series).

Edogg writes:

I meant that the drug war and lengthier sentences are not good proximate explanations. John Pfaff leaves open that they may indirectly increase incarceration.

ThomasH writes:

Assuming that the Great Depression was because of too-tight monetary policy, how does that explain rising wages. For that matter what explains the fact that the fastest rising component of demand was private investment?

Mark V Anderson writes:

Scott -- I think your point is that Japan's low unemployment rate and the drop in wages arise from different causes, and thus the concurrence of both at the same time is not a paradox?

But I still don't understand why there are dropping wages when there is also dropping supply. It makes sense to me that when the supply curve moves to the left, that prices increase. Since there are fewer new entrants to the labor force, I would think that firms would bid up the price to get their fair share of workers, especially since there are few of them unemployed.

You say that tight labor markets do not cause rising wages. Why not? It certainly seems logical to me.

Edogg writes:

ThomasH,

Assume wages are sticky in nominal terms. Then if prices decrease, real wages increase.

Mark V Anderson,

You're correctly describing the consequences of a fall in labor supply. But Scott's point is that the combination of a tight labor market and falling wages points to something else. (And since employment and wages are determined jointly, you can't use one to explain the other.)

Think of a market where the price is fixed above equilibrium. Quantity supplied is greater than quantity demanded. If the fixed price drops, quantity demanded will increase, quantity supplied will decrease, and the difference in the quantities will decrease.

Now identify workers as suppliers and companies as the demanders. Japanese prices rose due to monetary stimulus. Nominal wages are sticky, so real wages fell.

ThomasH writes:

My question was somewhat different. I wanted to know Scott's interpretation of the Great Depression.

vikingvista writes:

ThomasH,

I'm curious too. But I gather by "never reason from a price change" he is saying that you can tell what the shock was if you go beyond being mystified by the price change, and also look at the quantity. Since employment (Q) decreased, and wages (P) increased, then we can deduce there was mostly a negative labor supply shock. Since "prices rose rapidly" and output fell, we can infer a more general predominant negative supply shock. If the keynesians weren't so myopic in their focus on demand, they wouldn't be so mystified.

So, if the quantity of private investment increased, one need look at the corresponding interest rates to determine if there was a corresponding predominant positive demand shock for investment, or a positive supply shock in loanable funds. My understanding is that the Friedman's convincingly showed the latter was not the case.

After the shocks are understood, THEN one theorizes about why such shocks occurred.

So I gather, then, that your question is, "Why was there a positive demand shock for private investment?"

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