In the past few days there´s been some back and forth among MM´s following George Selgin´s “A question to Market Monetarists”. In that post GS writes:
My third reason for hesitating to endorse proposals for doing more than merely sustaining the present 4-5 percent NGDP growth rate is the one I consider most important. It is also one that has been gaining strength since 2009, to the point of now inclining me, not only to keep my own council when it comes to arguments for and against calls for more aggressive monetary expansion, but to join those opposing any such move.
My third reason stems from pondering the sort of nominal rigidities that would have to be at play to keep an economy in a state of persistent monetary shortage, with consequent unemployment, for several years following a temporary collapse of the level of NGDP, and despite the return of the NGDP growth rate to something like its long-run trend.
Apart from some die-hard New Classical economists, and the odd Rothbardian, everyone appreciates the difficulty of achieving such downward absolute cuts in nominal wage rates as may be called for to restore employment following an absolute decline in NGDP. Most of us (myself included) will also readily agree that, if equilibrium money wage rates have been increasing at an annual rate of, say, 4 percent (as was approximately true of U.S. average earnings around 2006), then an unexpected decline in that growth rate to another still positive rate can also lead to unemployment. But you don’t have to be a die-hard New Classicist or Rothbardian to also suppose that, so long as equilibrium money wage rates are rising, as they presumably are whenever there is a robust rate of NGDP growth, wage demands should eventually “catch down” to reality, with employees reducing their wage demands, and employers offering smaller raises, until full employment is reestablished. The difficulty of achieving a reduction in the rate of wage increases ought, in short, to be considerably less than that of achieving absolute cuts.
U.S. NGDP was restored to its pre-crisis level over two years ago. Since then both its actual and its forecast growth rate have been hovering relatively steadily around 5 percent, or about two percentage points below the pre-crisis rate.The growth rate of U.S. average hourly (money) earnings has, on the other hand, declined persistently and substantially from its boom-era peak of around 4 percent, to a rate of just 1.5 percent.** At some point, surely, these adjustments should have sufficed to eliminate unemploymentin so far as such unemployment might be attributed to a mere lack of spending.
And so, my question to the MM theorists: If a substantial share of today’s high unemployment really is due to a lack of spending, what sort of wage-expectations pattern is informing this outcome?
Scott Sumner replied:
Let me admit right up front that the relatively slow adjustment of wages and prices is not 100% consistent with the natural rate model that I have in the back of my mind. Krugman has made the same concession. George was kind enough to send me a graph showing wage growth and NGDP growth over the last decade, which will help me to answer this question:
The unemployment rate peaked at 10% in 2009, and has since fallen to 8.2%. Notice that a huge gap opened between NGDP and wages in 2009, and that gap has partially closed. Just eyeballing the graph, it looks to me like perhaps 40% of the gap has closed. And that’s pretty consistent with the fall in unemployment from 10% to 8.2%, if you assume 5.6% is the natural rate. (I.e. a 1.8% drop is roughly 40% of the 4.4% drop needed.)
But George is right that there is another problem here; why haven’t wages adjusted more quickly? Recall that in the 1921 recession (caused by severe deflation) wages fell quickly, and employment grew rapidly after wages adjusted. What’s wrong with our modern labor market? Or is the market fine, but I’m in error assuming the natural rate model explains recessions?
Meanwhile GS did another post: “…And my own attempt at an answer”:
Here (referring to the chart above) one can clearly see how, while NGDP plummeted, hourly wages kept right on increasing, albeit at an ever declining rate. Allowing for compounding, this difference sufficed to create a gap between wage and NGDP levels far exceeding its pre-bust counterpart, and large enough to have been only slightly reduced by subsequent, reasonably robust NGDP growth, notwithstanding the slowed growth of wages.
The puzzle is, of course, why wages have kept on rising at all, despite high unemployment. Had they stopped increasing altogether at the onset of the NGDP crunch, wages and total spending might have recovered their old relative positions about two years ago. That, presumably, would have been too much to hope for. But if it is unreasonable to expect wage inflation to stop on a dime, is it not equally perplexing that it should lunge ahead like an ocean liner might, despite having its engines put to a full stop?
But in an addendum he “backtracks”:
ADDENDUM (July 9, 2012): It turns out that the graph I concocted appears after all to have misled me (I confess I was apparently too willing to be convinced that there might be a case for further NGDP stimulus after all); playing around with it further (by using the same scale for both plots and letting 1/1/2005=100), I come up with another that actually reinforces the position I took in my original post:
In light of these further findings, I’m back to my original question: has the Fed, despite the still high level of unemployment, already done all that it ought to do in the way of monetary easing despite the still high level of unemployment?
The simple task of ‘rescaling’ a chart should not be enough to change one´s mind (or “mislead me”). If it does, there´s something missing in one´s reasoning.
Actually, the ‘rescaling’ could be even less ‘drastic’ than the one performed by Selgin and the ‘conclusion’ would be the same. For example, I picked his original chart and just rescaled the right axis to a narrower range (110 to 145 instead of 152). The result is that the wage-NGDP gap is much narrower at present.
In post today Bill Woolsey comments on Selgin:
To my reading, by the time the recovery started, Selgin thought it least bad to just accept the new baseline and then allow for slow, steady nominal income growth from there. Perhaps at his preferred one percent trend. (I may have been reading too much into his remarks.) To me, this is the implication of growth rate targeting.
Nominal GDP growth rate targeting would be for nominal GDP to grow the targeted amount from wherever it happens to be. While level targeting is often characterized in terms of catch up growth (or slowing,) I think this sort of definition makes growth rate targeting somehow fundamental. To me, level targeting means that the target is a series of levels going out into the future. Pick a future date, and there is a target level associated with that date. You can look at the rate of increase in the target levels. You can calculate a growth rate between some current value of nominal GDP and the targeted level at some future date. But the target for any future date is the level–not some growth rate from the current value.
And ends with a ‘punch’:
Market Monetarists are well aware that it is possible that potential output has fallen about 13 percent below the trend of the Great Moderation. (The CBO estimate of potential output is about 7 percent below the trend of the Great Moderation.)
And perhaps the equilibrium quantity of labor has fallen some huge amount too. The supply of labor decreased along with the demand, or the supply of labor is very elastic.
But I don’t believe it.
As I said before, I think a traditional recovery in nominal expenditure, like that of the Reagan-Volcker years, would be appropriate. And then we should move to a long run, noninflationary growth path for nominal GDP.
I think Bill gets it right. My take:
The following panel shows the behavior of NGDP and wages (the same wage definition contemplated by GS) over the 1964 – 2012 (first quarter) period. This was chosen simply because the data for wages start in 1964.
The panel is divided into four periods; 1964 – 79 which closely conforms to what is known as “The Great Inflation”; 1980 – 86 which I have named “The Volcker Transition”; 1987 – 07 “The Great Moderation” and 2008 – 12 which I call “The Bernanke Depression”.
Look at the left hand column of the chart – “Great Inflation” and “Great Moderation”. In both instances, nominal wages track nominal spending very closely. In the “GI” period there´s a rising trend (in logs) in NGDP & wages. In the “GM” period the trend is (log) linear, meaning growth in both NGDP and wages are “constant”.
And that pattern, wages evolving alongside with NGDP, is what we should expect, be it because inflation is rising but also in the case inflation is stable.
The right hand column shows situations where that pattern is broken. This is associated with periods of more drastic adjustments. In the 1980 – 86 period monetary policy was geared to bring inflation down. That required a change in the path of NGDP. Initially NGDP growth slowed markedly. Inflation was brought down and wage growth slowed too, albeit much less than the drop in NGDP growth (which remained positive all along).
After inflation came down the “Volcker Moment” materialized and NGDP ‘sprinted up’, just as Bill Woolsey thinks should be done at present.
But looking at the lower right hand side chart in the panel one could argue, like GS did in his ‘Addendum’, that the economy has experienced it´s “Volcker Moment”. After all, hasn´t NGDP surpassed wages?
It sure has, but GS was on the right track before being ‘tricked by his chart’ when he took into consideration the BIG drop in NGDP after mid-2008. And that´s the defining characteristic of “Bernanke´s Depression”, something unheard off since 1938!
In that case, reasoning in terms of growth rates leads you into all sorts of errors. As Bill Woolsey reminds us:
During the Great Moderation, nominal GDP stayed on a very stable growth path. And now, it has shifted to a significantly lower growth path with a slightly lower growth rate. Market Monetarists favor level targeting and so it is natural for us to insist that the Fed should have kept the economy on the trend growth path and reversed any deviation. The only way to reverse any negative deviation is for nominal GDP to grow faster than trend.
And illustrates with MM´s by now traditional LEVEL chart:
And even if you assume a lower trend path, the economy is still deep inside “The Hole”.
The next panel shows the associated behavior of employment.
Punch line: Either GS will see University of Georgia wages being cut, level cut, or he should pray the Fed gooses up nominal spending.