Don't use monetary policy to boost wages
By Scott Sumner
I recently received notification of a new Brookings conference on wages:
On February 28, The Hamilton Project at Brookings will host a forum to explore the most effective policy options to revitalize wage growth, including: the potential for boosting wage growth through monetary policy; restoring a level playing field for workers; and using educational investments to raise wages for young workers.
I think it’s a big mistake to try to use monetary policy to boost wages, except in the trivial sense that a sound monetary policy is also good for workers in the long run. Unfortunately, I imagine the people involved in this project have a more ambitious agenda in mind—using expansionary monetary policy to tighten the labor market and boost real wages. That policy is likely to do more harm than good.
Here’s the average hourly real wage rate in recent years:
Notice that real wages shot upward during 2009, a time of falling NGDP. This is consistent with some\m research I did with Steve Silver (published in the JPE in 1989). We found that real wages were countercyclical during periods dominated by demand shocks, and procyclical during periods dominated by supply shocks. For example:
1. Real wages tend to rise during periods such as 1929-33 and 2008-09, when a negative demand shock reduces prices. This is because nominal wages are sticky, and the price level is in the denominator of the real wage formula.
2. Real wages tend to fall during periods dominated by supply shocks, such as 1974 and 1980. That’s because adverse supply shocks reduce productivity, and this reduces real wages.
In the graph above, you see a negative demand shock raising real wages in 2009, and an increase in productivity (fracking) raising real wages in 2015.
If you try to boost real wages with an expansionary monetary policy, you are likely to end up with the opposite result. Prices will rise even faster than nominal wages, causing real wages to decline. Furthermore, you risk destabilizing labor markets. If you do succeed in boosting wage growth, it will likely also cause inflation to overshoot its target, forcing the Fed to suddenly tighten monetary policy. In the past, that’s exactly the sort of destabilizing monetary policy that has typically led to recessions. We need to get past that sort of stop-go policy.
In the long run, the only way to assure that real wage increases are sustainable is through positive supply-side policies, such as reforming the tax system, cutting government spending, reforming market access to health care and other professions, and reducing restrictive zoning laws. A sharp reduction in cigarette taxes as well as drug legalization would also boost the real wages of workers in lower wage jobs.