There was no breakdown in the “Musical Chairs Model”

In his recent post at Econlog – Germany´s mysterious recovery – Scott Sumner muses:

Initially I thought that the sharp fall in the German unemployment rate might have reflected falling German productivity and slow population growth. But that doesn’t explain the NGDP figures. Germany actually created far more jobs than America, despite lower NGDP growth.

The next step is to look at compensation per worker. I couldn’t find hourly compensation data for Germany (outside manufacturing) but if one compares total compensation to total employment it looks like compensation in Germany rose by just over 12% per worker. The US figures appear to be just under 13% per worker. So it does not look like the German employment miracle was caused by low wages.

So what is the explanation then? As far as I can tell, the only plausible explanation (at least in an accounting sense) is a breakdown in my “musical chairs model.” In this model the level of hours worked reflects the interaction of NGDP and (sticky) nominal wages. It is assumed that total labor compensation is a stable fraction of NGDP.

[The “musical chairs model: Think of recessions in terms of the game of musical chairs.  When the music stops several chairs are removed, and a few participants in the game end up sitting on the floor.  Slow NGDP growth combined with sticky wages is like taking away a few chairs; several unemployed workers end up “sitting on the floor” (i.e. unemployed), as there is not enough aggregate nominal income to support full employment at the existing nominal hourly wage level.]

But there was no breakdown in the MCM, so the German recovery is not “mysterious”. As Scott mentions, NGDP growth in the US from 2007.IV to 2013.IV – 16.3% (not 14.2%), or 2.6% per year – was higher than Germany´s 12.8%, or 2.0% per year.  But the point is that over that span of time NGDP in Germany grew very close to its trend growth rate of 2.2% while in the US it grew at less than half the trend growth rate of 5.4%.

Actually, while in the last quarter of 2007 Germany´s NGDP was above trend, in the US it was slightly below trend. In other words, in Germany there´s no ‘gaping hole’ to be filled, while in the US there is! The charts illustrate.

Note: You can understand why the ECB (Germany focused) increased rates in April and June 2011. Germany was “back on trend”!

Related: “There´s nothing wrong with market monetarism“