Give One Point to Scott Sumner
David Leonhardt looks at the behavior of real wages in the latest recession.
A big reason wages have held up this time is inflation has been nearly absent. As some economic historians have pointed out to me, there is a historical parallel here. During the Great Depression, real wages for people who managed to hold onto their jobs did far better than one might have expected, thanks largely to deflation.
The implication is that if the Fed had pursued more inflationary policies in 2008 then we might not have had such high unemployment.
May 14 2010 at 9:51am
This confuses me a bit. Hasn’t the Fed pursued inflationary policies for the last two years? The Federal Funds rate is still close to zero I think. So, what would be more inflationary, negative rates?
May 14 2010 at 10:04am
We would have less unemployment because instead of gold being $1200/oz it would be $2500/oz and 5% of the population would be out panning for gold. Whatever works I suppose.
May 14 2010 at 10:04am
Um, except that, as everyone outside the ivory tower has noticed, inflation is much higher than being reported, and much of employees’ compensation is being cut in other ways (worse health coverage, lower 401k match, cutting back on fringe benefits, etc.).
So real wages are going down. Premise = wrong.
(Contrary to popular belief among economic statisticians, a 50% increase in iPod hard drive size does not cancel out a 50% increase in food prices.)
May 14 2010 at 10:08am
“(Contrary to popular belief among economic statisticians, a 50% increase in iPod hard drive size does not cancel out a 50% increase in food prices.)”
Good point. Much of what we think we know about the economy is wrong if our statistics have consistently underestimated inflation, which I believe is the case.
May 14 2010 at 10:11am
Just print money and toss it out of helicopters, so to speak. That’s the only way to drive the interest rate ‘negative’.
May 14 2010 at 11:20am
Scott Sumner argues that the federal funds rate is a poor indicator of monetary policy; a better indicator of monetary policy would be fluxuations in NGDP off its long-run growth path. A rising federal funds rate may actually be a sign of loose monetary policy in some circumstances.
Given an excess demand for money, the demand for loanable funds will decline. This pushes down nominal interest rates independent of the Federal Reserve’s monetary policy. However, real rates do not fall with nominal rates, because money itself is more expensive when there is excess money demand. Thus, by satisfying the excess money demand with an increased money supply, interest rates (and the fed funds rate) may actually increase with looser monetary policy.
I might have explained this wrong. Perhaps Scott Sumner may turn up himself and clarify.
May 14 2010 at 11:35am
‘inflationary policies in 2008’
We /had/ very high inflation in early 2008. PPI and CPI spiked very hard. Food prices jumped hugely, gas prices increased a lot. Oil was well over 140 dollars a barrel. Do you not remember this?
May 14 2010 at 11:56am
Food is certainly up and gas prices are back up. Even if other stuff has stayed the same, I can’t really do without food. Somehow I’m not seeing this increase in ‘real wages’.
May 14 2010 at 12:05pm
A fair enough claim, but do be sure that you don’t claim that compensation was stagnant in the previous recovery based on using wages and not total compensation. Some people use whichever measure is most convenient at the time.
May 14 2010 at 12:08pm
Price inflation is a very poor measure to use here. A better measure is price inflation in food and energy. However, that measure says that we are in a highly inflationary environment again (like we were in early 2008.)
May 14 2010 at 12:12pm
Does this make sense?
The Fed is foolish to attempt to influence GDP growth via interest rates. Interest rates effect inflation.
The Fed is foolish to attempt to influence interest rates via money supply. Money supply affects growth.
So I think you’re saying here that they should have increased money supply (more) to promote growth, while controlling inflation with higher interest rates.
This reminds me of a common misconception and counterintuitive reality about flying a plane. To reduce altitude you don’t push the nose down (that affects airspeed). To increase airspeed you don’t increase throttle (that affects altitude). If you want to lose altitude, you pull back on the throttle. To increase airspeed you drop the nose.
May 14 2010 at 12:48pm
The problem with Sumner’s theory is that he uses a mechanical interpretation of the quantity theory of money. Mises and Hayek warned that the only thing worse than ignoring the quantity theory was to interpret it mechanically. Sumner does just that. He thinks that if ngdp is falling, then Fed policy is too tight regardless of what the Fed is doing. But as uncle Milti used to write, the lags between policy and effect are long and variable (up to four years by some econometric estimate). So if ngdp is falling today, it partly the result of policy from previous years, so policy changes today will have no effect today.
And it is partly because there is no mechanical link between the quantity of money and prices. The effect of an increase in money supply on ngdp has many, many other factors to deal with, such as the stage of the business cycle.
In fact, Hayek proves in “Profits, Interest and Investment” that ngdp will collapse after a boom no matter what the Feds do with interest rates. Even if the Feds could make nominal interest rates negative at say -5%, the boom would still bust because the bust has to do with the shift in profits from once sector to another. In short, rising ngdp makes consumer goods profits much higher than profits for capital goods makers, so investment shifts to consumer goods makers. Unemployment collapses in capital goods, which then triggers the collapse in ngdp.
May 14 2010 at 1:57pm
Hayek advocated maintaining nominal expenditure growth in a recession.
What he argued against was trying to maintain output and employment in capital goods industries.
He did not oppose trying to maintain (and expand) employment and output in consumer goods industries.
According to Hayek, the core problem is a need to shift resource from capital to consumer goods industries.
Your theory, which amounts to a short run liquidity trap, is Keynesian.
May 14 2010 at 2:01pm
“[P]olicy changes today will have no effect today.” Only if they are covert or otherwise disbelieved by the public. A *credible* commitment to a change in monetary policy will have an immediate impact.
May 14 2010 at 2:16pm
With a gold standard, the CPI including food and energy would rise at a high annual rate for some months. (And it would fall rapidly as well.) And the CPI without food and energy would be more stable.
If we had a gold standard and were trying to measure improvements in standards of living, then quality adjustments would still be necessary.
Anyway, the federal funds rate doesn’t measure “inflation.” To the degree the Fed targets the interest rate, its inflationary or deflationary impact depends on the relationship between the market interest rates and the natural interest rate. The natural interest rate depends on saving and investment. It can change.
The quantity of money doesn’t measure inflation. It is an excess supply of money (a quantity of money greater than the demand to hold it) that impacts the purchasing power of money.
The purchasing power of money, in my view, is best measured by the GDP deflator. The quality adjustments impact the long trends and aren’t a problem. But I don’t think it is desirable to try to stabilize the purchasing power of money in the face of supply shocks to food or energy. Of course, I don’t favor stablizing the GDP delfator without those things. I favor stabilizing the growth path of final sales of domestic product.
J. Daniel Wright
May 14 2010 at 3:09pm
I don’t understand how you came to your conclusion: “if the Fed had pursued more inflationary policies in 2008 then we might not have had such high unemployment.”
By December 2008, the Fed had expanded the M1 money supply (year-over-year) by 15.9%! That is 2.5 standard deviations from the mean year-over-year growth of 5.1% since 1960. That puts it somewhere in the 90th percentile: not a statistically improbable move, but it does show the uncommon nature of the Fed’s actions.
If you had Dr. Bernanke’s job, how would you have expanded the money supply? By how much? How would your policies have counteracted the unwillingness of banks to cooperate in extending credit throughout the economy?
As a saver, I’m not exactly thrilled with my bank’s rates growing my principal but I am thankful that I haven’t had to contend with high inflation eroding it away. Higher inflation would have seen many more WSJ essays Rick Santelli-like TV soundbites attacking the Fed for expropriating from the financially savvy to bail out the unwise housing speculators.
May 14 2010 at 3:41pm
As the short run Philips Curve, properly interpreted, tells us, inflation higher than expected will lower unemployment, and inflation lower than expected will raise unemployment, all things equal. There has definitely been some inflation, especially if you take falling housing prices out of the equation. But has there been more or less than expected? Given inflation during past recessions, and expectations over the past couple years, I can’t help but wonder if people’s expectations of super high inflation exacerbated things.
May 14 2010 at 4:50pm
Bill, One of us doesn’t understand Hayek. I got my points directly from his Profits, Interest and Investment, which contradicts all of your points. PII is just a restatement of Prices and Production with a different starting point. And Hayek didn’t change anything in Pure Theory of Capital.
Philo: “Only if they are covert or otherwise disbelieved by the public. A *credible* commitment to a change in monetary policy will have an immediate impact.”
There is a lag of up to four years from policy change to effect on cpi. That is based on econometric analysis. So either the Fed is always covert or lacks credibility, or there is no immediate impact. Anyway, suppose it’s true that a credible change in policy has an immediate impact. What would that be? Are people supposed to empty their bank accounts because the Fed claims it intends to raise prices? The data doesn’t bear that out. It does indicate a very small immediate impact, but nothing like that which hits four years later. Maybe the Fed just doesn’t have any credibility, which I could understand.
May 14 2010 at 9:17pm
So I guess Arnold Kling is saying the Fed should have bought all the subprime MBS offered at face value to prevent M2/M3 from contracting?
May 14 2010 at 9:37pm
The fed has pursued the policy of paying interest on reserves for years. This is part of the broader effort to recapitalize the banks without killing shareholders and creditors, and it’s working. And it’s not inflationary. Sumner’s right about this.
May 15 2010 at 4:04am
Every once in a great long while, I get the distinct impression that economists might not quite know very much about what’s going on.
But it’s just an impression.
May 15 2010 at 11:40am
MernaMoose, and you would be right if you’re talking about mainstream econ. But I would encourage you to read Hayek’s “Profits, Interest and Investment”. It’s free in pdf at mises.org in the literature section under Hayek. I think that would change your mind about Austrian econ.
May 15 2010 at 12:43pm
Okay, I’ll check it out. Thanks.
May 15 2010 at 5:23pm
“[T]he lags between policy and effect are long and variable (up to four years by some econometric estimate[s]).” “[Data] indicate a very small immediate impact, but nothing like that which hits four years later.” Your “four year” lag sounds “mechanical” (what happened to “variable”?). And I thought it was supposed to be demonstrated by *econometric analysis*; now it’s by *data*?
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