The political economy of nominal wage targeting
WARNING: if you are not a macroeconomist you may not understand this post, even if you think you do. This is especially true if you are not a macroeconomist but think you know something about "political economy". (When I hear the words "political economy" I usually reach for my shovel.*) This post is an experiment. You, the reader, may be part of that experiment.
This post is partly about mutual incomprehension between macroeconomists and non-economists. But it's written mainly for an audience of macroeconomists. So stop and think before you come out swinging wildly in the comments.
This post is partly about mutual incomprehension between macroeconomists and non-economists. But it's written mainly for an audience of macroeconomists. So stop and think before you come out swinging wildly in the comments.
This post is in two (OK, three) parts. The second part is about likely reactions to the first part, and is the main part of this post.
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).
Is Nick's policy "anti-labour"?? Don't be silly. Of course not. You would get exactly the same average levels of real wages and employment with either target, unless there are some sort of weird non-linearities in the model, or if better short run performance in the face of short run shocks leads to a higher growth rate. It's got nothing to do with being pro- or anti-labour."
2b. Non-economists. I'm guessing here:
"Nick's policy is anti-labour. He doesn't want workers' wages to increase. If he sees workers getting a better deal, he wants the Bank of Canada to tighten monetary policy to increase unemployment to weaken their bargaining power to force wages down again. Nick's policy isn't just anti-labour, it's deeply immoral in using unemployment to fight against workers' interests."
Roughly right?
2c. This one's trickier. Suppose you were a labour union leader who also believed in (something like) New Keynesian macroeconomics. In other words, you had the macroeconomics of (say) Paul Krugman, but your job was to run a labour union.
Even if you thought, as a good New Keynesian macroeconomist, that the policy might either be better or worse than inflation targeting, depending on the precise model, you would be very wary of the policy.
First, a lot of your members would be against it, for the reasons given in 2b above.
Second, if the wage targeting policy were implemented, and even if you knew, as a good New Keynesian macroeconomist, that it would make little or no difference to real wages and employment, which is what you care about, and that it made no difference to whether unions are good or bad, it might make a massive difference to how your job was perceived.
Suppose you managed to get an above-target 3.5% wage increase for your members. Everyone might then say: "Oh, that's great for your group of workers, but it simply means that some other group of workers are going to have to accept a 1.5% wage increase, to keep the average at 2.5%, and the Bank of Canada is going to have to make sure there's enough unemployment to force some other group of workers to only get 1.5%!".
And you would be left desperately trying to argue: "No, it doesn't mean that, because our wage increase could mean that average real wages would go up, even though nominal wages can't, because prices could come down as a result of our wages going up.....because,....er,..., well , it's all to do with the long-run neutrality of money, and the difference between real and nominal wages, and.....err....let me try to explain to you how this works.....brothers and sisters."
Would you want your job to be perceived like that? Would you like your job to be to have to try to explain that an increase in your wages might mean a fall in prices and an increase in average real wages even though average nominal wages were fixed by the Bank of Canada? Even though your argument for the benefits of union power would be equally valid (or equally invalid) whether the Bank were targeting CPI or nominal wage inflation?
Of course you wouldn't. I wouldn't wish that job on my worst enemy. Instead, you would say "Oh, to hell with trying to explain all that in New Keynesian macro, let's just blame the Bank of Canada for not letting us increase wages without creating unemployment! I can explain that to my members."
3. Coda. Back to macroeconomists: given the likely plausible reactions in 2b and especially 2c above, I wonder if your 2a is the correct answer?
* "Political economy" has two (modern) meanings. It can mean political scientists bullshitting about economics. Or it can mean economists bullshitting about politics. Economists tend to use the words in the second sense. Non-economists tend to use the words in the first sense.
The original is actually the rather clever: "when I hear of culture... I unlock (entsichere) my Browning". Browning being both a poet and a make of gun.
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).
Is Nick's policy "anti-labour"?? Don't be silly. Of course not. You would get exactly the same average levels of real wages and employment with either target, unless there are some sort of weird non-linearities in the model, or if better short run performance in the face of short run shocks leads to a higher growth rate. It's got nothing to do with being pro- or anti-labour."
2b. Non-economists. I'm guessing here:
"Nick's policy is anti-labour. He doesn't want workers' wages to increase. If he sees workers getting a better deal, he wants the Bank of Canada to tighten monetary policy to increase unemployment to weaken their bargaining power to force wages down again. Nick's policy isn't just anti-labour, it's deeply immoral in using unemployment to fight against workers' interests."
Roughly right?
2c. This one's trickier. Suppose you were a labour union leader who also believed in (something like) New Keynesian macroeconomics. In other words, you had the macroeconomics of (say) Paul Krugman, but your job was to run a labour union.
Even if you thought, as a good New Keynesian macroeconomist, that the policy might either be better or worse than inflation targeting, depending on the precise model, you would be very wary of the policy.
First, a lot of your members would be against it, for the reasons given in 2b above.
Second, if the wage targeting policy were implemented, and even if you knew, as a good New Keynesian macroeconomist, that it would make little or no difference to real wages and employment, which is what you care about, and that it made no difference to whether unions are good or bad, it might make a massive difference to how your job was perceived.
Suppose you managed to get an above-target 3.5% wage increase for your members. Everyone might then say: "Oh, that's great for your group of workers, but it simply means that some other group of workers are going to have to accept a 1.5% wage increase, to keep the average at 2.5%, and the Bank of Canada is going to have to make sure there's enough unemployment to force some other group of workers to only get 1.5%!".
And you would be left desperately trying to argue: "No, it doesn't mean that, because our wage increase could mean that average real wages would go up, even though nominal wages can't, because prices could come down as a result of our wages going up.....because,....er,..., well , it's all to do with the long-run neutrality of money, and the difference between real and nominal wages, and.....err....let me try to explain to you how this works.....brothers and sisters."
Would you want your job to be perceived like that? Would you like your job to be to have to try to explain that an increase in your wages might mean a fall in prices and an increase in average real wages even though average nominal wages were fixed by the Bank of Canada? Even though your argument for the benefits of union power would be equally valid (or equally invalid) whether the Bank were targeting CPI or nominal wage inflation?
Of course you wouldn't. I wouldn't wish that job on my worst enemy. Instead, you would say "Oh, to hell with trying to explain all that in New Keynesian macro, let's just blame the Bank of Canada for not letting us increase wages without creating unemployment! I can explain that to my members."
3. Coda. Back to macroeconomists: given the likely plausible reactions in 2b and especially 2c above, I wonder if your 2a is the correct answer?
* "Political economy" has two (modern) meanings. It can mean political scientists bullshitting about economics. Or it can mean economists bullshitting about politics. Economists tend to use the words in the second sense. Non-economists tend to use the words in the first sense.
The original is actually the rather clever: "when I hear of culture... I unlock (entsichere) my Browning". Browning being both a poet and a make of gun.
Comments
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But the essential underlying issue is interesting, and not just in this very limited targeting context, but how the same dynamic plays out in lots of other areas too. Like fiscal policy decisions. Or regulation.
It also kind of demonstrates why the mostly undiluted macro view of Krugman has almost always turned up the right answer as of late. And why the policy-shaded work of the Chicago folks or his Royal Idiocy Niall Ferguson has proven dismally wrong of late.
Is there more to it, or is it just reasonable to assume that the average person doesn't understand inflation?
I suppose though if those benefits feed through to the firm's marginal cost, then it would have the same macro-economic effect as the wage increases that they are replacing.
I cannot imagine any central bank would like to get stuck in the quagmire of attempting to quantify the benefits and costs of new OH&S or healthcare benefits...
In both cases (nominal wage target and CPI target) he wants to argue that average real wages will increase if his members get a 3.5% wage increase
1. With the Bank of Canada holding the time path of average nominal wages constant, he would have to argue that his members' above-target wage increase would cause the price level to fall.
2. If instead the Bank of Canada were holding the time path of average prices constant, he would instead have to argue that his members' above-target nominal wage increase would not decrease other workers' nominal wages.
Both arguments 1 and 2 are economically equivalent. But rhetorically, it would be easy to convince people of 2, but very hard to convince people of 1. I would hate to have to try to explain 1 to people using words, and no math or diagrams. It would be really easy to give an answer to 2 that sounded totally convincing, even if the reasoning was total BS.
"Hey, if our wages go up, and the Bank of Canada holds prices the same, that means our real wages go up, right? And if our real wages go up, that means average real wages must go up too, right?"
That argument above sounds convincing, right? But it's total rubbish.
How about this:
"Yep, if our money wages go up, that does mean that some other workers' money wages must come down. But that means the Bank of Canada will have to force prices down to makes some other workers' wages go down. So that means average real wages will go up, right?"
That argument sounds totally unconvincing. But it's much more correct than the above.
OK. Let's run with that. But, what that means is that there's a big long run non-neutrality of monetary policy, if you are right. Nominal wage targeting will lead to higher long run non-wage benefits and lower real wages than CPI targeting. Weird, huh?
As for the optics of it, you could always hold a nice public ceremony with your favorite central banker pledging to decrease prices. Because that's what would have to happen, right?
David: neat! But I find it hard to imagine. Reminds me of Keynes' "monetary policy by the Trades Unions" bit.
Is this an attempt to explain why Scott Sumner gave up arguing for a wage target? Or how different central bank's targets might have weird effects?
I mentioned wage targeting to someone (a non-economist I suspect) on a forum once. He didn't believe that a central bank could influence the wage level.
I suspect the union leader might take the easy route and argue against the central bank's wage target. It's up to the good guys to explain to the public why it's a good target. I doubt it will be easy. Likewise for NGDP level targeting. Why shouldn't we keep inflation and unemployment low any more?
From the perspective of 2c), would the policy choice not be more palatable if it does not so explicitly target one specific sector of the populace (i.e., workers). A clever pro-labour economist would realize that the policy choice nearly guarantees 2.5% increases in wages, which is a good thing. However, how does he or she sell it to labour, when they realize that their paychecks are being targetted during good times? Just consider the potential problems if when during the next expansion the BoC acts to restrain wage growth, while corporations and business owners are making record profits.
Whether or not the policy is unfair, it will be perceived as unfair, with the workers losing out, whether true or not.
To be *really* cynical, the other group doesn't get to vote in my re-election, so the point is moot (obviously this is more appropriate if you have craft unions rather than OBU).
I don't know why Scott gave up, but this is one reason why any central bank would think twice before targeting wages. (And why the Bank of Canada never talks about the natural rate of unemployment, but instead talks about "potential output").
But that point is sort of obvious. It's more about how different central bank targets might have weird effects.
Kosta: "But it is splendid how you've highlighted that CPI targetting does the same thing."
All monetary policies would do the same thing. Therefore none can be immoral.
Alex: "To be *really* cynical, the other group doesn't get to vote in my re-election, so the point is moot (obviously this is more appropriate if you have craft unions rather than OBU)."
Most economists would react: that's not being really cynical; that's obviously how it is.
The reason you get effective price level targeting from wage targeting is becuase in New Keynsian/DSGE models wages are effectively the only "variable" that determines price labor unions bosses know that's not true. Anyway, I agree that we should not be using DSGE models to bullshit about politics.
it is probably one of your easiest post for non-macro economist. You often use ad curves and stuff like that...
student in first year intro class learn the difference between nominal and real wage.
I think 2b is exagerated. I think many people can be educated about the difference between real and nominal wages. 2a is correct.
The way I gave up explaining why it would good for workers to raise Hydro rates and use the proceeds to hire nurses instead of paying C$ 100 K to high school dropouts working in a subsidized aluminum plant ( that's where I lose them....)
Economics and political science were long the same thing . In Canada they officially separated in 1958 IIRC.
If you think it is hard to explain sound economic policy, try vaccinating against cervical cancer in Texas.
the diference between targets for core inflation and targets for some wage rate index
are matters of fine tuning
the core target is a fig leaf for what in esence is a control of the rate of change of wage rate
overt control would be completely non PC
'nough said
btw
target wage rate not wage rate change
use policy to follow a path of nominal wage rates
get knocked off return to path asap
excellent point
and precisely why price targets are prefered by us pro union nitwits
now if you had a nominal value added per hour target ....then the "bossdes" might take the loses " eh ???
I think to really understand througly issues, you need at least an MA
is a second dimension to wage rate change
perhaps the union claims we had higher unit output so our impaact on unit cost is zero or just 1% and under the target etc
price indexes correct for changes in out put
are you correcting for changes in output per hour ????
i'm sure others have made all these points in comments above
just wanted to second these points in a sloppy way
this post is exactly what i like to see academic macrotoons doing nick
I think to really understand througly issues, you need at least an MA"
that is dangerously off course
i think the ranks of macronaut cadets trained in graduate schools after say 1982 got brain washed
of course 101 texts have aught up with the brain wash more or less
samuelson first edition would lead to better macro then most current graduate courses
i recall my own course under phelps at columbia
occured during the expectations revolution
and already this
plus the so called wage push inflation of the 70's
created a generation of half wits
shuttering in the shadow of inflation
you have modeled a wonderland again
weird as in primary signifigant different effects
if as you have you abstract for real target numbers you remove the debate
i suspect you share the pair of knocking knees the words wage inflation trigger in those "effectively " conditioned in grad school post 1979
lets look for weird secondary effetcs of changes in target type
not changes in target numbers
ya the monk and his conjury of an infinitude of extensionless angels
making a nice practical field like macronautics
into a semblance of the philosophy of mind
lets get to it brothers and sisters
the point is selecting the right target level
whether its inflations of prices or wages
and given shocks and internal eruptions that number changes from contect to context from major event to major event
we now have a rising debt to gdp ratio
i suggest that pushes higher targets onto the agenda
nick seems to think he wants a for all time and contexts rate on the safe side of zero
imagine suggesting deflation even in one sector given current debt loads
look at the giips
they need germany to raise its wage rates yes acclerate wage inflation
in a community of brains orbiting the rowe sun
this is monstrous it violates optimal rate change norms
btw
this is nicely brief aand sharp
"...And why the Bank of Canada never talks about the natural rate of unemployment, but instead talks about
"potential output"..."
yes they are one and the same
much to the misdirecting of the populace
if we look to the arsenal of democracy years ghere in the states 1940-1944
we see the huge elastcity of actual "potential output