Co-blogger Scott Sumner quoted correctly from an article in The Economist:
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.
READER COMMENTS
Andrew_FL
Mar 14 2016 at 9:02pm
The return of the high wage doctrine into serious politic discourse is a sad commentary on the state of economics as a discipline. Can anyone imagine chemists having to beat back phlogistonists every few generations? If evolutionary biology was perennially plagued by a Lamarckian scourge?
Bizarre.
ThomasH
Mar 14 2016 at 10:13pm
Nope!
The Fed caused the Depression by failing to maintain nominal NGDP growth. Heck, it even allowed deflation!
Richard A.
Mar 14 2016 at 11:30pm
It would be interesting to look at who was advising Hoover and Roosevelt to intervene in the market to prevent a decline in the price and wage level. Just looking at the equation
GDPn = P x GDPr
it should be obvious that a decline in GDPn of 1/2 means that P is going to have to decline by 1/2 in order to prevent a decline in GDPr.
There are two lessons from the Great Depression–don’t allow a massive decline in nominal GDP and don’t get in the way of a downward adjustment of the price and wage level.
David R. Henderson
Mar 14 2016 at 11:33pm
@ThomasH,
Your statement doesn’t contradict mine.
Daniel Kuehn
Mar 15 2016 at 7:46am
Richard A. –
That’s not obvious at all. That’s an identity. It says nothing about the behavioral determinants of p or GDPn. What would you think if I said:
“It would be interesting to look at who was advising Hoover and Roosevelt to intervene in the market to prevent a decline in the price and wage level. Just looking at the equation
Y = C+I+G+(X-M)
it should be obvious that a decline in Y of 100 means that G is going to have to go up by at least 100 in order to prevent a decline in GDPr.”
Dan in Euroland
Mar 15 2016 at 8:31am
David,
The point of contention is that in deflationary spirals “basic economics” does not work. The expectations channel can cause such supply side policy to be expansionary.
For interested general readers see the introduction to Gauti Eggertsson’s “Was the New Deal Contractionary” here: https://www.brown.edu/Departments/Economics/Faculty/gauti_Eggertsson/papers/AER_2012.pdf
Richard A.
Mar 15 2016 at 1:01pm
@Daniel Kuehn
It’s the supply and demand for money that determines nominal GDP as shown by the equation
M x V = GDPn
Since the Fed controls the money supply, it can offset any shift in velocity and control nominal GDP.
During the Great Depression, the Fed allowed the money supply to decline by about 1/3 and the resulting increase in the demand for money caused the velocity of money to decline by about 1/6 causing nominal GDP to decline by about 1/2.
Daniel Kuehn
Mar 15 2016 at 8:15pm
Richard –
Right it’s precisely because it’s an identity that you can decompose any change in the RHS into changes in the LHS. That tells you nothing about policy.
MV=GDPn is just as much of an identity as GDPn=P*GDPr. In fact they’re the same one.
Andrew_FL
Mar 16 2016 at 10:33am
All-I highly recommend reading Jason Taylor and George Selgin’s “By our Bootstraps: origins and effects of the High-Wage Doctrine and the Minimum Wage”
The idea that dictating higher wages could boost aggregate demand is quite foolhardy.
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