A new study supports The Midas Paradox
In my book entitled The Midas Paradox, I argued that FDR’s NIRA wage program set back economic recovery by almost 2 years. Prior to the wage increase, industrial production had surged by 57% in 4 months, mostly due to the stimulative effects of dollar devaluation. After July 1933, however, hourly wages surged by over 20% in just 2 months, despite nearly 25% unemployment. As a result, industrial production started falling, and did not reach July 1933 levels for another two years. I also documented four other wage shocks during the New Deal, each of which led to a pause in growth.
Other researchers, such as Gauti Eggertsson and Paul Krugman have argued for a “paradox of toil”, where at the zero wage bound an artificial attempt to force wages higher may actually be expansionary. (I emphasize “may”; Eggertsson and Krugman were prudently cautious on this claim.) The idea is that this sort of policy can boost inflation expectations, and hence reduce real interest rates.
In my view inflation doesn’t matter, what matters is expected NGDP growth. Artificial attempts to raise wages do not boost expected NGDP growth. Instead, as nominal hourly wages rise (for any given level of NGDP), hours worked fall.
Vaidas Urba sent me a new NBER study, by Jérémie Cohen-Setton, Joshua K. Hausman, and Johannes F. Wieland, which confirms my view of wage shocks:
The effects of supply-side policies in depressed economies are controversial. We shed light on this debate using evidence from France in the 1930s. In 1936, France departed from the gold standard and implemented mandatory wage increases and hours restrictions. Deflation ended but output stagnated. We present time-series and cross-sectional evidence that these supply-side policies, in particular the 40-hour law, contributed to French stagflation. These results are inconsistent both with the standard one-sector new Keynesian model and with a medium scale, multi-sector model calibrated to match our cross-sectional estimates. We conclude that the new Keynesian model is a poor guide to the effects of supply-side shocks in depressed economies.
In The Midas Paradox I did mention the French experiment, and speculated that it provided another example of the contractionary effects of artificial attempts to raise wages. However, I did no formal empirical study of that episode.
I’ve recently argued that the simple AS/AD model is superior to more sophisticated new Keynesian models with upward sloping AD curves. It’s good to see another confirmation of the workhorse AS/AD model.