Sunday, November 27, 2011

The Federal Reserve and Stagnating Wages

I've written before about stagnating household wages in the US. My sense is that while wages have stagnated in recent decades, the growth living standards have not, and issues in the provision of government goods, education, and healthcare have a lot to do with why growth in income isn't keeping up with growth in real consumption spending.

Mike Konczal has proposed one different explanation centered on the recent behavior of the Federal Reserve:

Here’s a question I’ve been trying to find research on lately – how much is the post-Volcker era of monetary policy responsible for stagnating wages and high-end inequality? I’m pretty familiar with the stories and arguments surrounding these two topics, and the Federal Reserve never shows up. It’s almost like taking an American phone charger overseas; there’s no place for monetary policy to “plug-in” the current research and arguments, from technology to superstars to policy to everything else, on wages/inequality.  Which is weird, since when you read transcripts of their FOMC meetings, released years after the time when they were recorded, the board members are obsessed with wages.   We have a sense of the Greenspan Put for the financial sector, but what’s the Greenspan option-metaphor for workers?

I was pretty skeptical of this idea when I first heard this. By what mechanism does the Fed targeting wage growth instead of CPI growth actually manifest itself into stagnating wages? Still, I wasn't able to think of a more effective argument against this on the spot. Nick Rowe, in a recent set of posts on related issues, argues against this idea much better:

1. Consider this policy proposal:
"I think the Bank of Canada should switch from targeting CPI inflation to targeting wage inflation. I'm not hung up on the exact rate of wage inflation the Bank should target. My guess is that something like 2.5% wage inflation would be roughly right, and would give us roughly the same 2% CPI inflation in future. But if you want to argue for a higher or lower target rate of wage inflation, I don't really care a lot. So if wages start to increase faster/slower than 2.5%, the Bank of Canada should raise/lower interest rates, reducing/increasing demand for goods and labour, which would put downward/upward pressure on wage increases."
(BTW, I'm not actually proposing that, though it's not a bad policy, and is worth considering. And the merits or demerits of that proposal is not the point of this post.)
2. Reactions.
2a Macroeconomists. Any New Keynesian (for example) macroeconomist would react to the above policy proposal like this:
"Ho hum. Nothing new here. Nick hasn't even given us any reasons why targeting wage inflation would be better than targeting CPI inflation. I could build a model where one would be better in some cases, and the other would be better in other cases. It all depends on: whether wages are stickier than prices; on the source of the shocks; the exact specification of the model and its parameter values; and stuff like that. It might matter in the short run, but won't matter much if at all in the long run (unless better performance in the face of short run shocks leads to a higher growth rate).

The post goes on to discuss various other issues. But I think this snippet here captures the gist of the critique. Even if the Fed were somehow actually targeting wage inflation; there is a whole set of models out there that imply that the impact on actual real wages is a lot more indeterminate than you might think.

Of course, one could probably develop a model in which wage stagnation was the logical outcome of targeting nominal wages; or one could reject the New Keynesian paradigm entirely (in which case one should probably stop reading Paul Krugman as well). It was just nice for me to run into some critique (however ill-defined) against the idea that stagnating wages are due to the Fed's policy target.