Scott Sumner  

Don't use monetary policy to boost wages

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I recently received notification of a new Brookings conference on wages:

On February 28, The Hamilton Project at Brookings will host a forum to explore the most effective policy options to revitalize wage growth, including: the potential for boosting wage growth through monetary policy; restoring a level playing field for workers; and using educational investments to raise wages for young workers.
I think it's a big mistake to try to use monetary policy to boost wages, except in the trivial sense that a sound monetary policy is also good for workers in the long run. Unfortunately, I imagine the people involved in this project have a more ambitious agenda in mind---using expansionary monetary policy to tighten the labor market and boost real wages. That policy is likely to do more harm than good.

Here's the average hourly real wage rate in recent years:

Screen Shot 2018-02-09 at 1.45.58 PM.png
Notice that real wages shot upward during 2009, a time of falling NGDP. This is consistent with some research I did with Steve Silver (published in the JPE in 1989). We found that real wages were countercyclical during periods dominated by demand shocks, and procyclical during periods dominated by supply shocks. For example:

1. Real wages tend to rise during periods such as 1929-33 and 2008-09, when a negative demand shock reduces prices. This is because nominal wages are sticky, and the price level is in the denominator of the real wage formula.

2. Real wages tend to fall during periods dominated by supply shocks, such as 1974 and 1980. That's because adverse supply shocks reduce productivity, and this reduces real wages.

In the graph above, you see a negative demand shock raising real wages in 2009, and an increase in productivity (fracking) raising real wages in 2015.

If you try to boost real wages with an expansionary monetary policy, you are likely to end up with the opposite result. Prices will rise even faster than nominal wages, causing real wages to decline. Furthermore, you risk destabilizing labor markets. If you do succeed in boosting wage growth, it will likely also cause inflation to overshoot its target, forcing the Fed to suddenly tighten monetary policy. In the past, that's exactly the sort of destabilizing monetary policy that has typically led to recessions. We need to get past that sort of stop-go policy.

In the long run, the only way to assure that real wage increases are sustainable is through positive supply-side policies, such as reforming the tax system, cutting government spending, reforming market access to health care and other professions, and reducing restrictive zoning laws. A sharp reduction in cigarette taxes as well as drug legalization would also boost the real wages of workers in lower wage jobs.


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COMMENTS (20 to date)
Kevin Erdmann writes:

Great post.
Stable NGDP growth would be a de facto reduction in systematic risk, which means it would be a powerful source of both higher long tern growth and higher labor share of income.

Mike Sandifer writes:

I'm curious as to why there's a focus again on smokers. Instead of lowering the tobacco tax, why not subsize wages so that all the working poor are helped, but so there are still disincentives to smoking?

Sure, in places like New York, tobacco taxes should come down, but I thought taxing economic bads in the context of general subsidies for the poor was a good thing.

Eliminate income taxes for most and tax bads first, then move to taxing waelthy consumption, and lastly maybe have a payroll tax for some of the wealthy, as needed.

Matthias Görgens writes:

Mike, notice that Scott didn't pass judgement on whether lowering taxes in cigarettes would be good. Just that it would technically increase real wages for poor people (who are often smokers).

I don't know whether Scott like smoking, but it's good economics to keep an eye on customer surplus. The bad in smoking also mostly only hits the smoker herself. So less of a need to tax to internalise externalities. (For the record, I hate cigarette smoke.)

For a lot of purposes vaping is a superior substitute to smoking: you still get the beneficial nicotine without the tar. (Though not sure, whether vaping still provides eg the MAOIs that a few people want from their smoking.)

Matthias Görgens writes:

Mike, as for taxing for revenue: we should try and get as much of the total needed from land value taxation, before we touch other sources.

The supply of land is almost perfectly inelastic, thus won't be harmed by deadweight costs.

Matthias Görgens writes:

Mike, as for taxing for revenue: we should try and get as much of the total needed from land value taxation, before we touch other sources.

The supply of land is almost perfectly inelastic, thus won't be harmed by deadweight costs.

Matthias Görgens writes:

Mike, as for taxing for revenue: we should try and get as much of the total needed from land value taxation, before we touch other sources.

The supply of land is almost perfectly inelastic, thus won't be harmed by deadweight costs.

HL writes:

I agree, but I think you are undermining your own argument (a bit) about central bank communication on the macro variable targeting. What are the chances that ordinary Joe would understand "total compensation level target" as something other than the targeting of his own wages, not the macroeconomic aggregate?

Scott Sumner writes:

Mike, Tobacco taxes are at least ten times too high to be justified on externality grounds, and they are highly regressive. If you are looking to help low wage workers, there no better example of a slam dunk policy than lower cigarette taxes. I see no downside, and lots of upside.

Taxes should apply to consumption, negative externalities, and land.

Mike Sandifer writes:

Matthias,

The government substantial subsidizes healthcare for poor and elderly, so smokers are hurting us all.

Of course a land value tax would be efficient, so that's great as far as I'm concerned. That doesn't mean we shouldn't tax economic bads, even sans externalities.

Mike Sandifer writes:

Matthias,

The government substantial subsidizes healthcare for poor and elderly, so smokers are hurting us all.

Of course a land value tax would be efficient, so that's great as far as I'm concerned. That doesn't mean we shouldn't tax economic bads, even sans externalities.

Mike Sandifer writes:

Scott,

The level at which one should tax tobacco depends on goals. Is it merely to cover externalities, maximize revenue, or minimize smoking? I'm comfortable with taxing up to a level short of encouraging a significant black market. That's why I say tobacco taxes are too high in New York.

Am I wrong on utilitarian grounds?

Scott Sumner writes:

HL, I don't have any problem with a central bank targeting nominal average hourly wages, I just don't want them trying to raise real wages.

Mr. Econotarian writes:

The only problem with land value tax is whether you trust the government to properly assign value without corruption.

The nice thing about income taxes and sales taxes is that there is a fairly objective number to work with as the tax basis.

Mark writes:

Mike Sandifer,

Actually, smokers, in net, save the rest of us money because they die significantly younger, and for that reason tend to impose a smaller, not larger, cost-burden on the system than us longer living non-smokers.

Matthias Goergens writes:

Mr. Econotarian, there are mechanisms to available to let people value their own land for land value taxes.

Basically, you declare the value of your own land. But to keep you honest, that's the value you have to sell to any comer.

In any case, systematic overvalueing wouldn't be a problem: it would just correspond to a higher LVT rate. (Valueing that would benefit special interests would be more of a problem.)

Mike Sandifer writes:

Mark,

Even if true, I still favor taxes on tobacco. That's why I favor taxing up to the point near which significant black markets begin to develop.

Mike Sandifer writes:

On the Hamilton Project conference, it's such a dumb idea, it's amazing any economist would show up at all.

Scott Sumner writes:

Mike, You said:

"Am I wrong on utilitarian grounds?"

Yes, I don't think you can go above the externality cost on utilitarian grounds. At least not in any honest way. (Sure, I could advocate taxing anything I personally don't like, but would that be honest?)

Mr. Econotarian. You said:

"The only problem with land value tax is whether you trust the government to properly assign value without corruption."

I would base the tax on area, not value. By zip code.

You said:

"The nice thing about income taxes and sales taxes is that there is a fairly objective number to work with as the tax basis."

Sales taxes yes. Income taxes? Not even close.

Mike Sandifer writes:

Scott,

When it comes to utilitarianism, I don't think it's that simple. There are actually people who appreciate certain limits forced upon them that they'd never voluntarily adhere to.

Matthias Görgens writes:

Scott, I never really understood your area-by-zipcode idea. But I think in the end we can just look at how Hong Kong or Australian states etc are already implementing the valuation.

All of a sudden, zip codes changes would become even more hugely political than they are already. And people with eg expensive lakefront property wouldn't pay more than people a few km away from the lake.

There's a certain elegance about letting people self declare and working out some protocol to keep them honest. (It's trivial to do if you don't mind taxing buildings at the same rate as the land. Which might not be too bad a compromise, especially compared to alternatives like income taxes or stamp duties etc.)

As for smoking, yeah, the practical limit is the black market. On utilitarian grounds we should encourage people to look into Swedish snus or vaping. Let's not mix up nicotine with burning tobacco. (Some people might still want to burn tobacco anyway, but that portion is probably smaller than the portion of people interested in nicotine. That substance also protects against Parkinson's and helps with concentration.)

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