Never reason from a wage change
By Scott Sumner
The stagnation in wages despite a pickup in hiring over the past few years has been one of the recovery’s most perplexing puzzles. But maybe the real problem isn’t lack of growth. It’s that wages didn’t fall enough during the recession.
That idea was floated by none other than Federal Reserve Chair Janet Yellen during a speech on the labor market last month during an elite central banking conference in Jackson Hole, Wyo. She used a much fancier term — “pent-up wage deflation” — but it essentially means that employers are keeping workers’ pay flat now to make up for not cutting it during the downturn.
I love that first sentence—it’s like noting that prison populations have risen “despite” a fall in crime rates. Why not the reverse? How about: “There’s been a pickup in hiring in recent years because wages have stagnated.”
In microeconomics, 99% of “reasoning from a price change” fallacies involve assuming a supply shift, when in fact the demand curve has shifted. For instance, saying “Oddly, global consumption of oil rose in 2007 despite a large increase in oil prices.” In macroeconomics the usual mistake is exactly the opposite, assuming all changes are driven by shifts in demand. For instance, saying “Oddly, inflation stayed low in the late 1990s despite a booming economy.
Oddly, very few people understand that the supply and demand model allows for either curve to shift. Real wages are not reliably procyclical or countercyclical. They are acyclical. Both supply and demand for labor shifts are important.