Monday, January 12, 2015

The Non-Accelerating What Now Rate of Inflation

The NAIRU is back. Here's Justin Wolfers in the Times the other day:
My colleague Neil Irwin wrote about this slow wage growth as if it were bad news. I feel much more optimistic. ... It is only when nominal wage growth exceeds the sum of inflation (about 2 percent) and productivity growth (about 1.5 percent) that the Fed needs to be concerned...
Read that last sentence again. What is it that would be accelerating here?

The change in the wage share is equal to the increase in average nominal wages, less inflation and the increase in labor productivity. This is just accounting. So Wolfer's condition, that wage growth not exceed the sum of inflation and labor productivity growth is, precisely, the condition that the wage share not rise. If we take him literally -- and I don't see why we shouldn't -- then the Fed should be less concerned to raise rates when inflation is higher. Which makes no sense if the goal is to control inflation. But perfect sense if the real concern is to prevent a rise in the wage share.


  1. The change in the wage share is equal to the increase in average nominal wages, less inflation and the increase in labor productivity.

    If the increase in capital income went up at the same time, wouldn't they stay the same or close? You'd have absolute wage gains without a relative increase in the share of income going to labor.

    1. Labor productivity = output per worker. If real wages (wages less inflation) are rising faster than output per worker, then the share of non-workers (i.e. the capital share) must be falling.

      Strictly speaking, this is only necessarily true in closed economy. It is possible for wages to rise faster than labor productivity plus inflation without the wage share rising, if the current account deficit is also rising.

    2. I'm also ignoring changes in relative prices. If we deflate wages by an index of consumer prices and factor shares by the GDP deflator, then in principle real wages can rise faster than inflation without the wage share rising. Price indexes do behave quite differently historically. But again, not what Wolfers is talking about.

  2. It seems to be a confused post on Wolfers part. He's contrasting his "positive" take with Neil Irwin's "negative" take. At the beginning he writes "What’s informing Neil’s reading is a concern about wage stagnation. Like Neil, I’m concerned that over a period of several decades real wages have barely risen, even as productivity has continued to race ahead. The result is that workers have enjoyed few of the fruits of economic growth."

    And then he differentiates between real and nominal wage increases, which I don't follow. "Even if nominal wages were rising quickly, we have no idea how much of that will translate into higher real wages, because we don’t know the extent to which businesses will pass through higher labor costs into higher inflation."

    Businesses won't do that if they are forced to pay higher wages because of tight labor markets. In the end, Wolfers says it's good we're not seeing wage growth because it means the Fed doesn't have a reason to tighten.

    But we want to get wage growth and we want the Fed to hold off tightening until labor shares in productivity gains, as Wolfers admits at the beginning. His post seems pointlessly contrarian about what Irwin had written.

    1. read his twitter feed:

    2. "Annual wages growth is running at 1.7%. Yellen says "normal" is 3.5-4%. The recovery has a long way to run before the Fed needs choke it off"

    3. Right. What he's saying, in effect, is: "We have no idea how much nominal wage increases will be passed through to prices, therefore we should assume that 100% of nominal wage increases will be passed through to inflation." Which does not make sense, unless holding down wage growth is an end in itself.

      And yes, the sad thing is that Wolfers is on the liberal side of this debate. He at least wants unemployment to be lower, as long as nobody is getting a raise.

  3. I think the idea is something like this:

    1) There is a "natural" wage share (as per Samuelson's side of the capital controversy);
    2) As long as there is slack in the economy, when the govenment stimulates the market responds by increasing production and employng more people, so the wage share doesn't change; when there is no more slack in the economy the NAIRU is crossed and nominal wages increase faster than inflation + growth;
    3) But as the "natural" wage share is fixed by technology, this automatically translates in an acceleration of inflation that restores the "natural" wage share.

    In fact, this is more or less the definition of the NAIRU.

    But, aside from the fact that the Sraffa's side of the capital controversy is IMHO the correct one and there is no natural wage share, this logic leads to the fact that, when the wage share falls, this is attributed to "technology" and is seen as inevitable, while when the wage share rises, this must generate inflation and should be prevented - a ratchet mechanism that in the long term causes the fall of the wage share.

    Piketty too seems to think in these terms when he says that maybe the natural state of the economy is just very capital intensive and this is what caused the increase in inequality on the long term.

    However, I think that it is quite hard to define the NAIRU if the wage share is not supposed to be fixed at some "natural" level.

    Also, I think that there is at the bottom a wrong idea about how real wages rise:
    Suppose, for example, that Apple produces a new and better model of the Iphone; this would lead to an increase in productivity and, for unclear reasons, the wages of Apple workers should rise.
    But this is not what happens, instead what happens is that wages of Apple workers stay still, but as the new Iphone sells at the same price of the old one but it is supposed to have an higer real value, real wages of everyone rise a bit.
    In short there is a sort of "productivity deflation".
    At the same time, there is a general increase in wages and prices, that we could call "monetary inflation".
    "Real" inflation then is equal to monetary inflation minus productivity deflation.

    I have no idea on what causes "monetary inflation", but it is clear that if we define monetary inflation as the increase in some sort of quantity of money, it is equal to real inflation + real increase in productivity, so it is generally higer than real inflation, and this is the reason goldbugs believe that real inflation is much higer than what it is, because unconsciously they are thinking to monetary inflation, not to the "real" one.

    Also, if I'm correct and increases in real wages are caused by what I called "productivity deflation", I have no idea of what causes changes in the wage share.

    1. when the wage share falls, this is attributed to "technology" and is seen as inevitable, while when the wage share rises, this must generate inflation and should be prevented

      That's a good point. There is a funny asymmetry in the mainstream discussion of wages. For liberals like Wolfers, if wages are rising faster labor productivity, that's a sign of excess demand that the Fed needs to do something about. But if wages are rising more slowly than productivity, as they most have been for decades, that's a sign of technological change, or China, or something else that has nothing to do with demand.

  4. Wolfers is the distilled essence of a certain kind of conventional wisdom. I'm not even sure it makes sense to call him 'liberal' except in the sense of not-a-Republican-ideologue. Not sure he has thought out the implications of his views, they are almost reflexive ideological pronouncements in certain quarters.