Chair Yellen Looks Under New Rocks, Finds Same Thing that’s Under Old Rocks

August 24th, 2014 at 11:12 am

I yield to no one in my admiration for the careful, thoughtful, and reality-based economics practiced by Fed Chair Janet Yellen. So I was taken aback a bit by a section in her Jackson Hole speech on Friday.

It was the part where she gave a number of reasons why the absence of wage pressures may not, paradoxically, be signaling that considerable slack remains in the job market, and therefore, may not be signalling that the Fed should wait on raising rates to stave off faster inflation.

I certainly appreciate bending over backwards to look for reasons why the obvious may not be correct—i.e., why the lack of wage growth might not be the sign of job market weakness I think it is. Sure, one should always shave with Occam’s razor, but you can knick yourself if you shave too close.

Still, I don’t think that’s the case at all here. To the contrary, each of her three reasons look like additional reasons not to slow the economy and preempt wage growth by tightening too soon. She’s right to look under new rocks, but as I see it, she found nothing new there.

The three “rocks” are:

nominal wage rigidity: because employers tend not to reduce nominal wages—it’s bad for morale—they don’t need to offer raises now as the job market’s improving. The implication is that diminished slack would not, as expected, be reflected in faster wage growth.

OK, but if this analysis is correct then the key question is “what does the absence of wage pressures–due not to labor market slack but to rigid wages–imply for monetary policy right now?” And the answer is: it implies that until inflation erodes real wages enough to generate more employment demand (i.e., moving down the demand curve), or until there’s enough labor demand to necessitate hiring at current real wage levels (i.e., the demand curve moves out), there’s no reason to tighten.

structural (i.e., longer-term, non-cyclical) forces that are reducing labor’s share of national income: Yellen cites the role globalization is playing in holding down wage growth for those negatively affected by international trade (I’d add imbalanced trade, as per here). Moreover, she connects this development to the decline in labor compensation as a share of national income and the analytically related point of real compensation growing more slowly than productivity.

But again, go back to the question in italics posed above (is this a reason to tighten sooner than later?). As Dean Baker and I recently wrote, “wage growth paid for by a shift back toward to a more normal split between wages and profits is non-inflationary.” It will take very tight labor markets to rebalance “factor income shares” (the profit and wage shares of national income) and to offset the damage to labor demand and worker bargaining power from imbalanced trade. So here again, pre-emptive tightening is contraindicated.

–depressed labor force participation that could be reversed by stronger demand: Here Chair Yellen pointed out that because millions of workers have left the labor force due to persistently weak demand, “transitory wage and price pressures could emerge well before maximum sustainable employment has been reached, although they would abate over time as the economy moves back toward maximum employment.” That is, depressed labor supply might lead to wage pressures in the near term, but as labor demand strengthened, those sideliners would get pulled back in which would then dampen those pressures, due to the added supply effect.

Even more so than the other two reasons, this one especially calls for extended monetary support of the job market. If we hope to raise the economy’s potential growth rate, it is essential for labor demand to strengthen enough to reverse that portion of the decline in labor force participation that’s reversible—the part due to weak demand (I’d argue that’s about half of the three percentage point decline, over two million workers).

So, not to put too fine a point out it, each of the three reasons Chair Yellen gave as to why the lack of wage pressure may not signal labor market slack actually point in the same direction in terms of monetary policy, as does the conventional wisdom that wage growth is weak because the job market is weak. Good for her for looking under interesting rocks to test the simple story, but what she found there leads to the same policy prescription: hold off on tightening.

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5 comments in reply to "Chair Yellen Looks Under New Rocks, Finds Same Thing that’s Under Old Rocks"

  1. Kevin Rica says:


    The following quote is definitely amongst your best work.

    ““what does the absence of wage pressures–due not to labor market slack but to rigid wages–imply for monetary policy right now?” And the answer is: it implies that until inflation erodes real wages enough to generate more employment demand (i.e., moving down the demand curve), or until there’s enough labor demand to necessitate hiring at current real wage levels (i.e., the demand curve moves out), there’s no reason to tighten.”

    You are absolutely correct that this concern for wage inflation needs to be imbalanced.

    This has been taken to a reductio ad absurdum level that the Fed must tighten any time wages start rising. So, of course they don’t. It shouldn’t be a surprise, it’s implicit in Fed policy (not to mention immigration policy) that we should prevent wage increases, no matter how much GDP or productivity grow.

    This is so imbalanced that it raises the question, “Is the Fed’s mandate to control inflation or protect profits”?

    Let me use one of my favorite Adam Smith quotes again:

    Our merchants and master manufacturers complain much of the bad effects of high wages in raising the price, and thereby lessening the sale of their goods, both at home and abroad. They say nothing concerning the bad effects of high profits; they are silent with regard to the pernicious effects of their own gains; they complain only of those of other people.

    Smith, Adam (2002-06-01). An Inquiry into the Nature and Causes of the Wealth of Nations (p. 68). Public Domain Books. Kindle Edition.

  2. Peter K. says:

    Two ways to look at this. One, they’re rationalizations for why they’ll start to raise earlier than expected given the data. It’s the same as the argument about how monetary policy (when tightening only it seems) has a lag, so they need to preempt inflation. This is what I’m afraid of. In a recent post Baker discusses how Greenspan wisely held off in the mid 90s much to the benefit of the economy, budget and society. The difference now from back then is we have Dodd-Frank, macroprudential policy and the memory of the recent housing bubble and financial crisis.

    Two, maybe she’s trying to say things are much better than they appear to be in the data and we should be hopeful that the economy will “snap back” and be more healthy so that we’ll forget about the secstags discussion. I’m hopeful. The Fed has also discussed how it would be a grievous error to tighten prematurely and send us back into recession near the zero bound forcing them back into unconventional policy and quantitative easing, something they’d rather avoid. Overshooting would be a form of insurance against this mistake.

    Tim Duy noted this via Reuters:

    “Approaching a historic turn in U.S. monetary policy, Janet Yellen has staked her tenure as chair of the Federal Reserve on a simple principle: she’d rather fight inflation than another economic downturn.

    Interviews with current and former Fed officials indicate that Yellen and core decision-makers at the U.S. central bank are determined not to raise interest rates too early and risk hurting the fragile U.S. economy…

    …The nightmare scenario she wants to avoid is hiking rates only to see financial markets and the economy take such a hit that she has to backtrack. Until the Fed has gotten rates up from the current level near zero to more normal levels, it would have little room to respond if the economy threatened to head into another recession.”

    Duy hasn’t commented on Jackson Hole yet.

  3. John Dennis Chasse says:

    Well, there is monopsony and oligopsony to explain why wages remain stagnant. In addition, there is the migration of capital from north to south, from the industrial to the non-industrialized world. In other words, there are problems that monetary policy alone cannot solve.
    Which brings me to Paul Krugman’s column in today’s Times. While my heart is with him, my head is not. Corporate executives prefer a low-wage, weak union environment. The correct response to all this, in my view, is to recall the reason for the Constitution in the first place. States were adopting beggar-thy-neighbor economic policies. There are reasons for learning from the EU on things like tax harmonization. In addition, it is time to admit that the Taft-Hartley Act is responsible for much of the decline of unions and the the consequent decline of the middle class.

    • smith says:

      Where to begin? It’s not just Taft-Hartley.
      When industry shifted from factory work to office work, employers figured out how to make their employees exempt from the Fair Labor Standards Act. They would call them professionals. It started in the 1950s. But there were important regulatory changes that Bush II implemented midway in his administration that further eroded labor rights. Obama is belatedly trying to reverse a few of these, most notably by raising the maximum wage cutoff beyond which employees are automatically exempt. When you’re exempt, you are salaried, and can be worked any number of hours, not just without time and a half, but for actually free. Hence at the start of a recession, productivity spikes. Actual self employed businessmen (and women) and professionals can make more money by working more hours, but not so the average worker. Walmart employees have been told they were supervisory or management even if they didn’t actually manage anyone. Computer programmers in the 1990s were given a special exemption since it was otherwise so obvious they were the new factory workers. Unions get a bad rap deservedly so for being corrupt, inflexible, and preventing meritorious promotion. They won’t be staging any comeback without addressing those issues. The more business friendly South home to relocating factories and businesses owes a lot to the advent of air conditioning, which allows the factories to run in the summer, and workers to chill at home.
      Perhaps the way to stop companies from blackmailing states for tax breaks is to tax the benefits they would otherwise receive, if the phenomena can’t otherwise be constitutionally banned. There’s also work to be done trying to halt the perpetual flow of blues state money to red states.
      Breaking up businesses and halting mergers and consolidations would be an important first step in pricing by fiat, and lack of wage competition, illegal collusion of google and apple notwithstanding.