Never reason from a price change, even in Japan
By Scott Sumner
Here is The Economist:
IF ABENOMICS means anything, it is the promise of the prime minister, Shinzo Abe, to restore healthy economic growth to Japan and end years of deflation. To that end the central bank, sloughing off its traditional caution, has flooded the economy with money and encouraged the yen to slide. Mr Abe has wooed investors with a resolutely upbeat message about Japan’s prospects. As a consequence, the stockmarket is up by three-fifths since Mr Abe came to office in late 2012, and even property prices in Tokyo are rising after years in the doldrums. . . .
On the one hand, the labour market is tight to bursting. That is partly because of strong demand for workers in, for instance, construction. But it is also because the population is shrinking fast. The number of Japanese is predicted to fall from 127m today to under 90m by 2060. Every year the working-age population falls by about 1m. Today unemployment stands at just 3.7% (dream on, Spain).
Yet despite a tight labour market, real wages continue to tumble (see chart). In May they fell by 3.8% compared with a year earlier–the steepest decline in years. That is despite the government’s use of moral suasion to get companies to hike basic pay in annual wage negotiations with unions this spring. Officials marched into boardrooms to demand higher pay for workers.
That reminds me of when the New York Times ran a headline saying prison populations were soaring “despite” a fall in the crime rate. Market monetarists would say there is no “conundrum” to be explained. Tight labor markets do not cause rising wages—the relationship between wages and employment depends on whether the economy is hit by a demand shock or a supply shock.
In this case, the BOJ did some monetary stimulus in 2013. This caused Japanese prices to start rising. Since nominal wages are sticky in the short run, rising prices led to lower real wages. Real GDP rose and unemployment declined.
Of course if you look at the world through Keynesian glasses then this all seems very confusing. Many economists have trouble understanding why prices rose rapidly in the US during 1933, “despite” high unemployment.
It’s also important to note that one should not make the opposite error, assuming that low real wages will always be associated with a strong labor market. In 1974, real wages in the US fell due to an adverse supply shock. And the unemployment rate rose sharply.
Never reason from a price (or wage) change. First ask what caused the price to change. Then it will all make sense.