After many years of 2% wage growth, nominal average hourly earnings are finally accelerating, up to 2.8% in October (year over year). This reflects the fact that the (downward) wage adjustments in the wake of the Great Recession are over, and the economy is near the natural rate. (Unemployment is 4.9%, while the broader U-6 rate just fell to 9.5%, lowest since April 2008.)
Some people are saying the Fed should give the economy “more room to run”. They shouldn’t be a bunch of meanies who are tightening policy just when workers are finally getting a raise. I certainly don’t want the Fed to be a meanie, but the 2.8% nominal wage growth is actually the strongest argument for a rate increase—even stronger than the low unemployment.
Most people confuse nominal wages with real wages. The Fed controls nominal wages, but what matters to workers (in terms of living standards) is real wages. If the Fed were to try to raise real hourly earnings with an easy money policy, it would fail. And the reason is blindingly obvious. Yes, easy money would boost wage growth, but it would also boost inflation.
Could you argue that the wage growth would occur first, and then the inflation? Sure, you can argue anything, but it’s not true. Wages are sticky, and tend to be a lagging indicator. So no, the Fed has no power to increase real hourly wages, at least over any extended period of time.
Of course they might briefly raise real wages by suddenly tanking the economy through tight money. That would depress commodity prices, and the CPI inflation rate would quickly fall well below the (sticky) wage inflation rate. That’s exactly what happened in 2009—how’d that work out for America’s workers?
A better argument for easy money is that the economy still has slack, and that while faster growth would not boost real hourly wages, it would boost total wage compensation, by increasing hours worked. But the rising wage inflation rate suggests that there is not much slack left in the economy. Maybe a little, but not very much.
An even better argument for easy money is that the Fed has been undershooting its inflation objective, and TIPS spreads suggest it will continue doing so. On the other hand TIPS spreads may be biased, and both the Fed and private sector forecasters expect roughly 2% inflation going forward.
The reason that 2.8% wage growth is the single best argument for tightening is that the Fed seems committed to roughly 3% NGDP growth as a long-term trend. In my view, that implies roughly 2.4% hourly wage growth as a long run equilibrium, and about 0.6% growth in hours worked per year. Thus the recent numbers are actually above the new average (if I’m correct.) It looks to me like the Fed is going back to its old game plan—procyclical monetary policy.
Just to be clear, as long as the Fed is doing inflation rate targeting (not level targeting) I believe a 3% NGDP trend is too low. It will leave the Fed poorly prepared for the next recession. They should either switch to NGDP level targeting, or raise their inflation target. But if they insist on staying with the current target, then it would be a huge mistake to try to “give workers a raise”. It would not even do what the proponents hope for, and it would destabilize the economy.
When commenters try to characterize my monetary policy views, they almost always get it wrong. That may be partly because I’m a poor communicator, but I suspect it’s also because most people think in simplistic terms, along a linear hawkish/dovish scale. That’s not how I approach monetary policy. I think in terms of regimes, not whether the Fed is too easy or too tight at the moment. Based on their preferred regime they are probably about right. Based on my preferred growth rate regime they are too tight. Based on my preferred level targeting regime they are about right. All statements about monetary policy must be viewed in context.
Here’s analogy. Is someone driving west on I-94 past Kalamazoo, Michigan going in the right direction? Well, it depends on whether they hope to end up in Chicago or in Detroit.
READER COMMENTS
James
Nov 6 2016 at 1:39pm
Scott,
You wrote: “That may be partly because I’m a poor communicator…”
Since you mentioned it, much of your advocacy for NGDP targeting comes across as “My way would be better in some way and by some amount that I cannot specify. The other guys just don’t understand me.” Given the way you have talked about NGDP targeting, it would be irresponsible for any central bank to adopt it. If the most vocal advocate for an idea can’t make a specific and testable prediction of what the benefits of that idea will be, that’s a pretty good reason not to implement it.
To be absolutely clear, what I am talking about is something like, “Under NGDP targeting, RGDP growth, unemployment and inflation will average X, Y and Z within confidence intervals x, y and z.” This would let the people considering NGDP targeting know what they are supposed to get out of it. Then, if some central bank implements NGDP targeting, specific forecasts of the effects of NGDP targing would allow people to look at the realized effects and see that NGDP targting is working as intended, or not.
P.S. I’ve made the same suggestion to you before and you referred me to papers which lack the very sort of forecasts I described. Please don’t refer me to papers you have written unless you can cite a page with specific forecasts of the consequences of NGDP targeting. Better still, repeat those same forecasts here.
Scott Sumner
Nov 6 2016 at 2:43pm
James, You said:
“To be absolutely clear, what I am talking about is something like, “Under NGDP targeting, RGDP growth, unemployment and inflation will average X, Y and Z within confidence intervals x, y and z.””
NGDP targeting would not have any significant impact on average RGDP growth or average unemployment. That’s my prediction, and that’s an implication of the Natural Rate Hypothesis. As far as average NGDP growth, I predict it would be whatever NGDP growth rate was chosen as the target. I’ve predicted that trend RGDP growth is 1.2%, so that means my inflation prediction is the NGDP target rate minus 1.2%.
The basic argument is that RGDP growth and unemployment would be less volatile—that’s the advantage. I predict that RGDP volatility would be slightly less than during the Great Moderation of 1984-2007. Does that answer your question?
foosion
Nov 6 2016 at 2:56pm
How would NGDP targeting affect the real economy (e.g., RGDP and employment)?
You write “A better argument for easy money is that the economy still has slack, and that while faster growth would not boost real hourly wages, it would boost total wage compensation, by increasing hours worked” and “NGDP targeting would not have any significant impact on average RGDP growth or average unemployment”.
It seems odd that it could increase hours worked, but not average unemployment or real hourly wages.
Perhaps you could expand on this?
Gordon
Nov 6 2016 at 3:41pm
Scott, I have a question that is a bit of a tangent from the main point of your post. You mentioned the unemployment data that came out with last Friday’s report. When I was looking through it, something puzzled me. The household data showed a decline of 43,000 in the number of employed people. The unemployment rate came down because 200k people dropped out of the work force. I’m assuming this is due to retirees as the LFPR of 25 to 54 year olds went up. So I’m wondering how the payroll data showed a 160k increase in jobs while the household data shows a decrease in the number of employed people. I thought it might be due to an increase in the number of multiple job holders but that was not the case. Have you seen any explanation that reconciles the household data with the payroll data? I assume there’s a margin of error in the household survey data but would it be significant enough to account for most of the difference?
Scott Sumner
Nov 6 2016 at 6:23pm
Foosion, It can increase employment at a point in time, but doesn’t effect the natural rate of unemployment.
Gordon, Yes, the statistical error in the household data is very large, so people look at the payroll data for month to month changes. The household data can be useful for spotting very long run changes.
foosion
Nov 6 2016 at 6:31pm
Scott, I suppose the next question is whether the Fed can keep employment above equilibrium for an extended period and whether this might reduce the natural rate.
Plus all the usual criticisms of the natural rate hypothesis, including whether there is a single equilibrium and its (their) stability.
James
Nov 6 2016 at 10:39pm
Scott,
Yes, that is exactly the kind of answer I was looking for.
When/if some central bank decides to adopt NGDP targeting, will you be willing to take bets on the consequences?
Andrew_FL
Nov 7 2016 at 12:40am
If you’re driving the country toward Chicago or Detroit, you should probably turn around.
Thaomas
Nov 7 2016 at 7:20am
I agree with your thesis that the Fed should not target the real wage even in the short run, I thing the Fed should tolerate a higher real wage if that occurs on the way to price level/NGDP level targeting.
Thanks BTW for including the clear distinction between “inflation targeting” and “price level targeting.” I would like to see a model in which inflation targeting is superior to price level targeting. I’m not up to doing such a model (maybe you are not either) but Beckman or Rowe?), but my vague sense is that the costs of bad inflation/price level is that they make it more difficult to predict future relative prices and that to me sounds like the target should be some future average level not some path or rate of change for getting there.
Therefore when you say
I am frustrated. This leaves out the possibility of price level targeting. Perhaps NGDP level targeting is even better than price level targeting, but is seems to me a bridge a little bit farther politically and hence not the best thing to long for at the moment. Price level targeting is closer to what most people who have not observed what “inflation targeting” means in practice — an inflation ceiling, mean by “inflation targeting, that the Fed misses it target symmetrically.
Additionally, I think that your post does not deal with the the political resistance to doing “whatever it takes” to do either price level NGDP level targeting. Is it concerns about the Fed’s balance sheet or the speed of interest rate adjustments or something else?
Finally, I suspect that the model that explores the differences between price level and inflation targeting will need to consider the variables — whatever they turn out to be — that explain the political resistance to “whatever it takes.”
Thaomas
Nov 7 2016 at 7:39am
Additional comment about communication. I think it would be helpful if you would just come out and say that from your preferred regime on date X the fed should have been buying or selling asset Y that would affect the interest rate of that and or other assets in Z way.
bill
Nov 7 2016 at 9:01am
Great post.
Tactical question. When the Fed tightens next would you recommend that they start shrinking their balance sheet? Or continue increasing payments of IOR?
Scott Sumner
Nov 7 2016 at 3:13pm
foosion, I don’t think they can reduce the natural rate. Th experience of the 1960s and 1970s suggests it’s not a good idea to try.
James, I don’t bet on policy questions, although I suppose if the bet were attractive enough I’d consider it. But I will gladly predict outcomes, if the plan is adopted.
Thaomas, Yes, I should have mentioned price level targeting as an option.
I don’t see there being much political resistance to doing whatever it takes, mostly because a promise to do whatever it takes actually leads to the central bank not having to do as much.
You said:
“I think it would be helpful if you would just come out and say that from your preferred regime on date X the fed should have been buying or selling asset Y that would affect the interest rate of that and or other assets in Z way.”
Don’t you think readers might wrongly presume that I wanted the Fed to do that, even if they were using their own regime?
Bill, I definitely prefer a smaller balance sheet. I’d rather they remove almost all the excess reserves, before ANY rate increases.
Gordon
Nov 7 2016 at 4:21pm
“Bill, I definitely prefer a smaller balance sheet. I’d rather they remove almost all the excess reserves, before ANY rate increases.”
Excess reserves have declined by almost 300 billion dollars since mid September. What I wonder though is if the Fed is so fixated on the idea of interest rates being the monetary policy transmission mechanism that it doesn’t realize that it’s tightening policy by reducing its balance sheet.
bill
Nov 7 2016 at 4:33pm
I thought the same thing. Reduce the balance sheet first. I’ve emailed some Fed members on that too. So far I’ve had no effect. LOL
bill
Nov 7 2016 at 9:03pm
@ Gordon
Wow, that’s a lot. I’d like to see that continue. Carefully and probably more slowly. IOR is too blunt and needs to be ended.
Comments are closed.