Scott Sumner  

Never reason from a wage change

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Bryan Caplan has a post showing that Janet Yellen is one of the sensible Keynesians, who understands the problems caused by sticky wages. Here's the Washington Post discussing Yellen's views:

The stagnation in wages despite a pickup in hiring over the past few years has been one of the recovery's most perplexing puzzles. But maybe the real problem isn't lack of growth. It's that wages didn't fall enough during the recession.

That idea was floated by none other than Federal Reserve Chair Janet Yellen during a speech on the labor market last month during an elite central banking conference in Jackson Hole, Wyo. She used a much fancier term -- "pent-up wage deflation" -- but it essentially means that employers are keeping workers' pay flat now to make up for not cutting it during the downturn.


I love that first sentence---it's like noting that prison populations have risen "despite" a fall in crime rates. Why not the reverse? How about: "There's been a pickup in hiring in recent years because wages have stagnated."

In microeconomics, 99% of "reasoning from a price change" fallacies involve assuming a supply shift, when in fact the demand curve has shifted. For instance, saying "Oddly, global consumption of oil rose in 2007 despite a large increase in oil prices." In macroeconomics the usual mistake is exactly the opposite, assuming all changes are driven by shifts in demand. For instance, saying "Oddly, inflation stayed low in the late 1990s despite a booming economy.

Oddly, very few people understand that the supply and demand model allows for either curve to shift. Real wages are not reliably procyclical or countercyclical. They are acyclical. Both supply and demand for labor shifts are important.


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COMMENTS (4 to date)

Casey Mulligan has a blog post up that is on point;


A reduction in labor supply could reduce the quality of labor, with workers putting in less effort, or doing less to maintain their skills, or become less attached to the labor market. This tends to reduce cash earnings per hour because each hour is less productive. These have been major factors in the analysis of women's wages, where most economist believe that women's hourly earnings increased as a consequence of supplying more (see Becker 1985, Goldin and Katz 2002, Mulligan and Rubinstein 2008, and many others). See also some of the literature on unemployment insurance such as Ljungqvist and Sargent's paper on European unemployment.
A reduction in labor supply or demand could increase the average quality of labor through a composition bias. See p. 17ff of my book and the references cited therein.
Because of fringe benefits, cash hourly earnings are not the same as employer cost. As employer health insurance expenditure has been growing over time, the growth of cash hourly earnings has substantially under-estimated the growth of employer cost.

Edogg writes:

Scott, I'm a little unsure of what you're saying. My impression of what Yellen is saying is that wages are sticky downward and above equilibrium, so when the demand curve for labor shifts right, wages will stay the same until there is equilibrium at the current wage. But then you're third paragraph implies that the supply curve has shifted. But that will have no immediate effect if there's currently a surplus of labor. Am I mistaken or are you saying something else or what?

Benjamin Cole writes:

Actually, unit labor costs have bumped up a little bit in the first quarter, but then slipped again in send quarter, from FRED. Here is index of unit labor costs, non-farm business, from 2007 to present.

2007-01-01 100.878
2007-04-01 100.199
2007-07-01 99.387
2007-10-01 100.033
2008-01-01 102.034
2008-04-01 101.115
2008-07-01 101.725
2008-10-01 103.479
2009-01-01 100.139
2009-04-01 100.660
2009-07-01 99.899
2009-10-01 99.320
2010-01-01 98.118
2010-04-01 98.892
2010-07-01 98.843
2010-10-01 98.880
2011-01-01 101.501
2011-04-01 100.599
2011-07-01 101.411
2011-10-01 99.401
2012-01-01 102.126
2012-04-01 101.830
2012-07-01 101.360
2012-10-01 104.438
2013-01-01 102.547
2013-04-01 103.362
2013-07-01 102.612
2013-10-01 102.274
2014-01-01 105.108
2014-04-01 105.093

So, call unit labor costs up 5 percent from 2012, but also up 5 percent from 2007.

I wonder if looking at labor costs is something better done in the 1970s than now. Commodities too--they soared from 2000-2008, and nothing happened on inflation.

Actually, when I sum it all up, thinking about inflation or unit labor costs is the wrong approach too.

What we sought to think about is how to boost aggregate demand.

I think it will take a whole lot of prosperity to get inflation and interest rates up, maybe years and years of it. We just have to do it. People say we need higher interest rates, and I think they are right.

Scott Sumner writes:

Edogg, I think you misunderstood me, I agree with Yellen. I was just objecting to the "despite" in the news article.

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