Bryan Caplan  

Yellen is a Good Keynesian

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From: My Department of Credit Where Credit Is Due

I've previously insisted that when there's high unemployment, all good Keynesians should say "Wages must fall!"  I'm delighted to learn, then, that Janet Yellen is one of the good Keynesians.

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.


...By leaving workers' wages unchanged during the recession, businesses were essentially overpaying their employees. Once the recovery starts, they make up the difference the same way -- keeping wages flat despite an improving economy.

Normally, rising inflation during a recovery helps businesses reduce costs even if wages remain unchanged. But the recovery from the Great Recession has been characterized by particularly low inflation -- which is likely lengthening the time firms need to keep wages flat.

I wish Yellen's words were more emphatic.  But I'll take what I can get.

HT: Nathaniel Bechhofer

COMMENTS (7 to date)
Jason Sorens writes:

I just don't get the micro mechanism behind slow wage growth in recovery. Shouldn't new entrants bid up wages? They don't need to "make up" for anything! I understand money illusion on the way down, but how does behavioral econ get you upward stickiness?

michael pettengill writes:

Of course, Federal government technocrats failed to slash the debt owed by workers fast enough as well.

Remember, the US Constitution makes redistribution of wealth the sole province of Congress authorizing Federal redistribution technocrats known as bankruptcy judges, to redistribute the money from those who had it and lent it, to those who did not have it and borrowed it, and that after the borrowers lost wage income to repay the debt need have the cash they borrowed to make up for lost wages.

Before Reagan, government regulation denied debt to half the population, with the exception of government assisted land ownership. The threat of Federal bankruptcy law certainly served as a threat to reckless lenders.

Thus, before Reagan, if wages fell, GDP fell because no one produced much more than workers could afford to buy of what they produced.

Since, the effort is to have lower wages but higher consumption by "financial innovation" of something for nothing - consumption without income to pay for it.

Why hasn't anyone blamed the sluggish economy on the failure of prices to fall so that workers with stagnant wages can buy more of the stuff produced by higher productivity? We need a lot more bankruptcy redistribution of wealth to reduce effective prices on a means tested basis.

High inflation is just another way to redistribute wealth from those with wealth to those who borrow wealth, but it is not means tested and usually harms the frugal working poor the most.

Hunter writes:

Wouldn't a good Keynesian bemoan the fact that inflation is causing those with jobs to get less money over time and thereby lowering aggregate demand?

Thomas Boyle writes:

What Jason Sorens said. It is not obvious that employers can hold wages down when labor is tight (if they could, they would do it all the time), so there must be another explanation.

A possible one is that employees are loyal to employers who protected their wages during the recession. That loyalty need not just be "warm fuzzy" gratitude (although it can include that, too), but can reflect a recognition that having such an employer has value beyond the size of the pay check. Employers who buffer employees during downturns, may be able to recapture the cost during upturns by underpaying risk-averse employees. Interestingly, this could even work on new hires, if the company's employee-protection policies are sufficiently well known (think "government jobs", for example, or "tenured jobs").

vikingvista writes:

"Normally, rising inflation during a recovery helps businesses reduce costs even if wages remain unchanged."

So Yellen believes rapid economic growth devalues the dollar? Is she confusing the liquidation prices of pre-recessionary output to the prices of post-recessionary output? Or does she subscribe to the "overheated economy" theory of inflation?

Why would anyone expect wages to not appear stagnant as long as the employment numbers remain fairly low and unemployment benefits are generous? Doesn't that pool of unemployed-on-benefits have to returned to the workforce before wages can be expected to rise?

I think it unlikely that the apparent stickiness in wages has as much to do with emotion as it does with supply and demand--with supply in this case manipulated through government subsidies.

JA writes:

I've read, and it seems reasonable, that people have an "irrationally" negative outlook to their wages being cut, even in times of deflation where real income would not be declining.

Given the potential for really bad morale at a company, it might be preferable to fire more people than cut wages.

P.S. I've also read that before the Great Depression it was common for employers to cut wages during a recession, but either Hoover or FDR convinced many businesses to hold wages the same instead of cutting them. I think largely this tradition has been followed.

Brian Donohue writes:

Are Yellen's views here peculiarly Keynesian? Or am I just missing the boat?


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