Scott Sumner  

A new study supports The Midas Paradox

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In my book entitled The Midas Paradox, I argued that FDR's NIRA wage program set back economic recovery by almost 2 years. Prior to the wage increase, industrial production had surged by 57% in 4 months, mostly due to the stimulative effects of dollar devaluation. After July 1933, however, hourly wages surged by over 20% in just 2 months, despite nearly 25% unemployment. As a result, industrial production started falling, and did not reach July 1933 levels for another two years. I also documented four other wage shocks during the New Deal, each of which led to a pause in growth.

Other researchers, such as Gauti Eggertsson and Paul Krugman have argued for a "paradox of toil", where at the zero wage bound an artificial attempt to force wages higher may actually be expansionary. (I emphasize "may"; Eggertsson and Krugman were prudently cautious on this claim.) The idea is that this sort of policy can boost inflation expectations, and hence reduce real interest rates.

In my view inflation doesn't matter, what matters is expected NGDP growth. Artificial attempts to raise wages do not boost expected NGDP growth. Instead, as nominal hourly wages rise (for any given level of NGDP), hours worked fall.

Vaidas Urba sent me a new NBER study, by Jérémie Cohen-Setton, Joshua K. Hausman, and Johannes F. Wieland, which confirms my view of wage shocks:

The effects of supply-side policies in depressed economies are controversial. We shed light on this debate using evidence from France in the 1930s. In 1936, France departed from the gold standard and implemented mandatory wage increases and hours restrictions. Deflation ended but output stagnated. We present time-series and cross-sectional evidence that these supply-side policies, in particular the 40-hour law, contributed to French stagflation. These results are inconsistent both with the standard one-sector new Keynesian model and with a medium scale, multi-sector model calibrated to match our cross-sectional estimates. We conclude that the new Keynesian model is a poor guide to the effects of supply-side shocks in depressed economies.
In The Midas Paradox I did mention the French experiment, and speculated that it provided another example of the contractionary effects of artificial attempts to raise wages. However, I did no formal empirical study of that episode.

I've recently argued that the simple AS/AD model is superior to more sophisticated new Keynesian models with upward sloping AD curves. It's good to see another confirmation of the workhorse AS/AD model.

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COMMENTS (6 to date)
Andrew_FL writes:

I believe you once remarked that in analyzing the Great Depression you couldn't use W/NGDP because we lack quarterly data going back that far. Just thought I'd mention that FRED has series PI, M0868CUSM027SNBR, and M0868DUSM027NNBR, all monthly for personal income, which seems to correlate closely with NGDP. You could use those to estimate GDP on a monthly timescale back to 1929. Only problem is that the series covering 1929-45 needs to be seasonally adjusted.

Just to get an idea, here's what W/PI looks like. I've included the unemployment data. Interesting that no big change to W/PI occurs during the supposed recession associated with post war demobilization.

Scott Sumner writes:

Thanks Andrew.

Benjamin Cole writes:

Regulating wages is a bad idea. Thailand does not really regulate wages and the nation has no unemployment. In fact, labor shortages are the norm.

Thailand also has no inflation, but then it has very little property zoning.

The nation does practice protectionism. I suspect an element of crony capitalism in this. The policy has also the effect of directing demand into domestic Industries and employment.

The upshot of this protectionism is an exchange of somewhat lower living standards for higher social stability. Maybe a good for Siam.

I suspect the Thai central bank merely pegs the baht to the dollar so that's their monetary policy.

Push cart vending is legal in Thailand, adding to the tightness of labor markets and the ability of people to support themselves and start their own businesses.

I note that Western economies are quick to condemn wage regulations and protectionism, but rarely if ever mention property zoning and the criminalization of push cart vending.

Traveling broadens the mind!

Andrew_FL writes:

Some of what Mr. Cole has said about Thailand is apparently correct. A 2014 youth unemployment rate of 3.9% presumably indicates that unemployment is low in general, though FRED has no statistics on adult unemployment for Thailand for some reason. The inflation rate, judging from their consumer price index, has been low recently. Since about 2007, the Baht/Dollar exchange rate has generally bounced between a little over 35 to a little under 30 Baht to the dollar. I don't know if that qualifies to be considered a kind of pegged or not. I will observe that the Baht/Dollar exchange rate was basically fixed from July of 1981 til November of 1984 at about 23 Baht to the Dollar. Apparently after that, until mid-1997, they switched to a basket peg, 80% of the basket was the Dollar. The 1997 devaluation was associated with the 1997 Asian Financial Crisis. As far as I know, they're still at least nominally floating the Baht since then.

Not sure what he means by saying traveling broadens the mind. Has not zoning and such been his personal hobby horse for quite some time? How can something which confirms one's priors be considered mind broadening?

Ryan Murphy writes:

Isn't part of the idea that the mechanism the Keynesians describe implies that NGDP shouldn't be held constant? They aren't arguing that you are shifting between one mix of inflation and real output to another, they are arguing you are increasing nominal expenditures by shifting income from one group with a low MPC to one group with a high MPC. This is contingent on the central bank's policy function, but still. Is there another piece that I am missing?

ThaomasH writes:

Up until now I had analysed the New Deal as part (inadequate) monetary stimulus, part (inadequate) investment in NPV > 0 projects, part really dumb interventions like AAA and IRA and a few good (not perfect) interventions like the SEC and deposit insurance and part changed expectations about NGDP ("nothing to fear but fear itself"). Your book shows just how dumb the microeconomic mistakes were.

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