Herbert H Posen and Franklin D Blanchard
By David Henderson
In places stuck in deflationary quicksand it may be necessary to be more radical still. Olivier Blanchard and Adam Posen of the Peterson Institute for International Economics have argued that Japan would benefit from an incomes policy. Under their proposal the state would mandate an across-the-board 5-10% increase in salaries in order to jump-start a spiral in which high wages drive up prices that drive up wages, thus soon leaving deflation behind.
They really did advocate that. Their Financial Times post in which they did so is here.
Scott calls this idea “dubious” and points out that it’s what Franklin D. Roosevelt did during the Great Depression. Scott understated the case.
It’s also what Herbert H. Hoover did. Hoover’s measure helped cause the Great Depression and FDR’s measures helped make it “great.”
The basic economics is this. If the government forces wage rates to rise, as FDR did, or twists employers’ arms to raise wages, as Herbert Hoover did before him, employers will cut back on the number of employees they hire and will fire some. Output will be lower. So, yes, that will drive up prices. But that’s bad, not good. Real output will be lower than otherwise.