The wage/price ballet: keep the music going!

April 27th, 2016 at 10:33 am

I’m sure it’s no surprise that I’d like the Fed to announce later today that they’re holding rates steady and maintaining a pretty dovish stance. Inflation remains unthreatening, real GDP growth in the first quarter is likely to come in at <1%, and—the subject of this post—the typical (median) worker is only now getting a bit of a boost from the tightening job market. The last thing we’d want to do given these conditions is endanger that welcomed trend.

Though slack remains in the job market, as it has tightened, wage growth has picked up a bit, even at the median. The figure below shows the year-over-year growth rate of nominal weekly earnings, and the smooth lines, based on a model I’ll explain in a moment, cut through the jigs and jags, revealing a bit of upward mo.

Source: BLS, my calculations.

Source: BLS, my calculations.

The model predicts median earnings growth based on a labor market slack variable and two lags of the dependent variable. What about those bits at the end, where one wage forecast keeps going up and one flattens? Those are based on different assumptions of just how tight the labor market gets.

The wage line that flattens out at around 3.5 percent nominal growth by 2018 assumes that the job market gets to full employment (which, given the slack metric I used, accounts for not just unemployment but underemployment as well) by the first half of next year and stays there (Chair Yellen has named 3.5% as a target for average compensation, implying she views that pace as trend productivity growth + the Fed’s inflation target).

The wage line that continues to grow, hitting 4 percent, simulates a job market that’s even hotter, where the jobless rate is allowed to fall below what we think of as full employment. With this scenario, we’re basically simulating a labor shortage, which significantly lifts the bargaining power of middle-wage workers.

But wouldn’t that be inflationary?

Not so much, really. Research I’ve cited elsewhere suggests that the slope of the “Phillips Curve”—the correlation between slack and inflation—is flat right now, implying a low level of transmission from the tight labor market to prices.

In this spirit, the next chart shows the result of another modelling exercise, this time, predicting the growth rate of the CPI (Consumer Price Index) based on the same slack variable as the wage model, along with energy prices and an index for the dollar, as both of these factors predict overall price movements. As you see, predictions from this little model track the CPI pretty well.

Source: BLS, my calculations

Source: BLS, my calculations

The end of this figure shows inflation “firming”—slowly drifting upward—but at full employment, the CPI hits its target of 2.5 percent at the end of 2018. And remember, that target is an average, not a ceiling. As you see, it’s been missing to the downside, so it’s due for a walk on the wild-up-side.

The other simulation, where the Fed kicks back and lets the job market fall below full employment, has the CPI hitting 2.8 percent by the end of 2018. Slightly above target, but again, that’s as it should be, assuming (and here I’m donning the cloak of the central banker) that inflation expectations remain anchored around their target, meaning people expect them to eventually tighten and nudge price growth back to the target.

Obviously, this is all just modelling and all models are wrong. Still, these models are telling us something useful and plausible: tighter labor markets are delivering a bit of bargaining clout to middle-wage workers. In our age of inequality, full employment—and even fuller-than-full employment—are critical correctives to the skewed distribution of growth. Allowing these dynamics to proceed apace may generate some price pressures, but that too is as it should be given how weak inflation has been.

So let’s see what Chair Yellen and company have to say later this afternoon, but their right move, in my not-so-humble opinion, is to let this ballet play out as above.

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7 comments in reply to "The wage/price ballet: keep the music going!"

  1. Oliver says:

    dawning the cloak…. or perhaps donning the cloak? 😉

    Anyway, with you all the way. I never thought I would enjoy seeing “Help wanted” signs going up in the small South Carolina town where I live. It’s only anecdotal evidence and the jobs don’t likely pay well, but keep the music going for sure!

  2. urban legend says:

    Maybe even better: “It’s due for a walk on the high road.”

    I like the connotations of that.

  3. Bob says:

    Great group of models, so simple even my congressman could understand it. This close to the zero bound, deflation poses a much greater risk than inflation because the Fed has effective tools to quench inflation, but very little to counteract deflation. So Fed policy should be accommodative until actual, not anticipated, signs of inflation secondary symptoms appear.

    The executives of the big five banks have been pressuring the Fed to raise rates. The low rate environment is bad for bank profits and therefore incentive compensation for bank executives. Looking at the performance of their shares in the stock market, I see dead money for maybe the last ten years. Isn’t there a way for the Fed to get bankers their bonuses and option gains without screwing up the economic recovery?

  4. Dave says:

    So what causes secular stagnation today?

    Globalization, as exists today, emphasizes the efficient use of labor over a global economy. Efficient use of labor causes secular stagnation. Why?

    Because when developed nations utilize low-cost labor from other nations, it sucks demand out of the US economy. At the same time, it sucks labor from developing economies.

    It is interesting to say this is all describable in a foreign government buying US bonds, but it isn’t. To take the example of the US and China, China is doing nothing wrong in buying US bonds with its accumulated dollars achieved through utilization of their labor for US development. Nothing wrong with that.

    What does our use of their labor demand from their government? Nothing. We feed money into their economy that can only be used to buy US goods, which their people cannot afford. Buying US bonds is the best solution. But this is an agreement between governments — the US as agreed that we should utilize their labor as long as it is cost effective to do so. This puts US workers out of work. The Chinese don’t have any better use of the money except to buy US bonds. We understand that the Chinese bank exchanges the proceeds from companies, but what else should they do?

    Do you expect an authoritative government to make a decision that goes against their financial best case? Why? Does the US ever do this? No. This is our mistake. We have a so-called democratic government (questionable). It is upon us to demand that we let them use their own labor for their own causes. But we don’t.

    Want to model this? It is simple. Using that labor for US outputs is more efficient than using it for Chinese outputs because we’re more developed and more productive. However, this efficient use of labor prevents that labor from being used in China for their further development of internal demand. You see low demand in China as a result. It also robs the US of wages, which lowers demand in the US.

    Secular stagnation. Efficiency in this case is the enemy of growth in both countries.

  5. Dave says:

    Most people who claim that China is manipulating exchange rates claim that China should do something else with the proceeds of the use of their labor for US production. What should they do with it?

    Let’s say they stop investing and dump their bonds. Would that fix the secular stagnation? No. Why not?

    Because we’re still more productive than them. It still will produce more monetary benefit to allow their workers to work for us rather then them.

    Give the current set of rules, US companies have no reason to stop using their labor. The cost goes up a bit because of the exchange rate, but it will still be well below US labor costs.

    It won’t fix the problem. This is one place where Krugman was essentially right, and he once gave a rough calculation of exchange rate effects, and it didn’t come close to fixing the problem.

    Why would Krugman look the problem straight in the face and deny that globalization was a problem? You’d have to ask him. I don’t know. He’s a strange guy, in my view. Pride? Pride over the economics profession? Who knows.

    But the numbers don’t lie, and the problem is obvious. The problems is in our own policies of allowing the use of foreign labor for US production.

  6. Dave says:

    Ultimately, I’ve been convinced from the beginning that this is not really about economics but rather global politics. I would hope that you, Jared, having been in the room for major decisions would be ware, but not necessarily.

    Why? Need to know. Do you need to know? This is not that complex of a problem. Many of us, including Trump, understand that the US workers have been screwed. I have to believe it is some misguided attempt to achieve economic domination so as to prevent military confrontation.

    I think what the people deserve to know is that this a giant load of BS. The CIA doesn’t have the authority over US citizens to make these decisions. It might make their jobs seem more palatable, or it might make them feel like the world is more secure as a result, but they’re wrong as they have often been wrong.

    It is a travesty. Perhaps Krugman believes in their goals. Perhaps he really believes this keeps the world safer. He’s wrong! It is making the US more unstable, and what could be worse?

    I believe it is just poor decision making in the hands of the wrong people. The CIA has an essentially impossible task, and they often make decisions for the wrong reasons. The government is out of control in this respect, because it has ceased to behave in the best interest of American citizens. Is it going to require a Trump presidency to correct this?

    Perhaps. Unfortunately, perhaps.