Monetary policy (mostly) determines nominal wage growth
By Scott Sumner
Monetary policy drives NGDP growth, and NGDP growth (per worker) is by far the most important determinant of nominal wage growth. (The other determinant is labor share of GDP.)
During the past 4 years, NGDP growth has been running at 4.05%/year, well below the historical norms. So why is wage growth running at only about 2.5%/year? The answer is simple; payroll employment has been growing at 1.78% over that same period. The predicted growth in average hourly earnings is 2.27%, whereas actual wage growth has been running at 2.47%. The recent puzzle is why is wage growth so high, not low.
[If you look back over the past 8 years, you have NGDP growth averaging 3.92%, employment growth at 1.66%, predicted wage growth at 2.26% and actual wage growth at 2.23%.]
So why are so many people puzzled over the lack of wage growth? They make the fundamental error of confusing micro and macroeconomics, unfortunately a common mistake among Keynesians. Factors like international trade, tight labor markets, etc., may affect relative wages in particular fields. That’s microeconomics. But at the macro level, nominal wages are mostly driven by monetary policy. (Of course real wages are a different story, heavily influenced by productivity.)
There is no mystery as to why wages have recently been growing at 2.5%, not the 3.5% to 4% typical before the Great Recession. NGDP growth has recently been running around 4%, which is below the 5.4% trend before the Great Recession.
Wage growth is almost exactly what you’d expect given recent trends in monetary policy. There is no mystery to explain. The lesson here is to never confuse macroeconomics and microeconomics; they are radically different fields. Micro models cannot provide macro answers, for the simple reason that the factors that determine real prices are radically different from the factors that determine nominal prices.
PS. This Paul Krugman post is a typical example of the way most people think about wages. Krugman focuses on several microeconomic type explanations for slow wage growth, while missing the elephant in the room (NGDP growth).
PPS. David Henderson has a couple recent posts (here and here) where he is rightly skeptical of some explanations for the wage puzzle, but perhaps not skeptical enough. Caroline Baum has a recent article that also fails to mention NGDP growth, but does correctly note the link between slow real wage growth and sluggish productivity.