Inflation fear and privileged service sector jobs

by on April 4, 2012 at 6:33 am in Economics, Political Science | Permalink

The greater the number of protected service sector jobs in an economy, the more likely those citizens will oppose inflation.  Inflation brings the potential to lower real wages, possibly for good.  How many insiders, if they had to renegotiate their current deals, would do just as well?

Get the picture?

This is a neglected cost of protected service sector jobs, namely that the economy’s central bank will face strong political pressures not to inflate even when a looser monetary policy would be welfare-improving.

Western Europe most of all.  If you see that the young people in an economy aren’t doing nearly as well as the privileged insiders, you should suspect that the privileged insiders fear renegotiation and thus fear inflation.

Inflation is easier to sustain in rapidly growing economies where people are moving up various ladders quickly.

Perhaps we have lost the ability and the political economy to support inflation when needed.

Andrew' April 4, 2012 at 6:55 am

Why is inflation beneficial? Because debts are nominal, right? Why are debts nominal?

Andrew' April 4, 2012 at 9:03 am

Also, if lack of inflation were the problem, wouldn’t the inflation be absorbed before prices were radically changed?

JVM April 4, 2012 at 9:38 am

I think that if debts were in terms of CPI, there would be a financial crisis every time RGDP growth fell short of trend. Policy makers can’t decide RGDP so the crisis would lack a policy-oriented solution.

It’s supposed to be better that they’re nominal, since that means that a financial crisis will only be caused by a shortfall in NGDP relative to trend, which should never be a problem because the central bank controls NGDP and can simply prevent such a fall from happening. But as we learned this time around, the central bank doesn’t always step up to the plate.

Andrew' April 4, 2012 at 9:43 am

I kind of see it not as an either/or but since the government is the final arbiter of contracts and bankruptcies they could figure out how to enforce the “spirit” of the contract and in things like money that is more likely the real debt and anyone who specifically wanted nominal could structure things that way. As for The Fed, I’m not sure why retirees have to bear the brunt of the monetary policy mistakes. Why can’t we figure out a way for the government to have to pay if they mess up?

Rahul April 4, 2012 at 11:34 am

Aren’t (some) mortgages etc. tied to prime interest rates which effectively makes them non-nominal?

msgkings April 4, 2012 at 11:52 am

Not really. Some adjustable mortgages are tied to a short term rate like LIBOR, but that rate can stay very low (like now) even with 2% inflation (like now).

Willitts April 4, 2012 at 1:16 pm

Very few borrowers are taking out ARMs now, for reasons that should be obvious.

How sensitive ARMs are to interest rates depends on the base rate and the reset frequency.

Floccina April 4, 2012 at 12:23 pm

Better would be to short the value of the asset that you took a loan to buy. With all the new ETFs it could probably be done today. I.e. short housing.

Simon Cooke April 4, 2012 at 6:59 am

Is not the growing number of pensioners more of a political pressure? Given that retirees are more likely to vote and more likely to be active politically this might be just as important as the ‘elite’ protecting real wage levels\/

Benny Lava April 4, 2012 at 8:33 am

This exactly.

Floccina April 4, 2012 at 12:24 pm

+1

Mark April 4, 2012 at 7:01 am

Beautiful.

Jd April 4, 2012 at 7:15 am

Until I scrolled down and saw “Western Europe”, I fully expected you were writing about the US, Tyler. Though I possibly misread “service sector” for “public sector”.

the commentariette April 4, 2012 at 11:00 am

The employment situation of young people in Europe is so much worse than that of young people in the US that there’s simply no comparison.

It’s not just that the unemployment rates among young people are higher — it’s that there are two classes of employee — those with permanent jobs and those who have short-term contracts (young people).

The problem is that in most European countries, it’s extraordinarily difficult and extremely expensive to layoff an employee once s/he has been hired into a permanent position. So employers hire young people on short term contracts. But it’s only allowed to have someone on a short-term contact for half-year or year or so — after that guaranteed fired.

So even in countries with relative low youth unemployment (compared with 30-50% in Spain or Greece) young people who are working have even less job stability than their US counterparts. It’s not unusual, even for a graduate, to have had 15 or 20 jobs in 10 years or more.

By contrast, it’s easier for a young person to get a graduate job, employers don’t have to be confident they’ll be able to afford an employee forever. And they aren’t guaranteed to lose their job in 6 mos or a year, no matter how well they do…

Ed April 4, 2012 at 11:43 am

The situation is definitely worse than Europe, but there are signs of it spreading to the US.

I can see a future of work where short term contract positions are the norm. And this may be OK -there were downsides to the 9 to 5 regime- if the short term contract jobs pay well and health care is severed from employment (and it is severed from employment in Europe).

david April 4, 2012 at 7:57 am

FDR did appeal to farmers to support inflation vs the cities. Hmmm.

Bónapart Ó Cúnasa April 4, 2012 at 7:58 am

But surely it’s the eurozone periphery which has the insider-outsider labour markets (Spain above all), not the core? German Orderliberalisms doens’t arise from a desire to protect public-sector wages…

Master of None April 4, 2012 at 8:17 am

It’s very sad, and yes, the US suffers from the same problem. I am 27, and I think about this every day. My parents’ generation is permanently damaging the real earnings potential of my cohort, and I don’t see a way to overcome the problem, given the political realities.

I fear this may persist until the boomers begin to retire, perhaps until they begin to die out.

We should also consider the impact of high levels of savings by the boomer generation: demand for income-bearing financial assets has been pushed to the extreme, lowering expected future returns for the young people who do manage to save a little money.

Add to this the crushing burden of student loans for many would-be professionals, and there is very little room for optimism. They have taken our slice of the pie.

Pshrnk April 4, 2012 at 9:39 am

Greedy geezers eh?

Nate April 4, 2012 at 9:46 am

Boomers haven’t saved for shit. And what savings there were, were plowed into houses. Oops.

Ed April 4, 2012 at 11:50 am

In fairness, boomers were advised that the best way to save was to buy a house, and it used to be that was the best way to save.

Every attempt they made to save -investing in equities, buying a house, and so on, turned into an asset bubble. Even investing in the future (higher education) turned into an asset bubble. And in the private sector their defined pensions were replaced with 401Ks. So I think there is some evidence for the “greedy generation” meme but not so much for the “profligate generation” meme.

But I agree with the commentariate’s general point. I predict we will see a big, though short lived, economic boom in 20-30 years as the boomers die and the transfer payments to them stop. At that point they will finally be out of the work force, and where their positions haven’t been automated employers will be looking to replace them. People will wonder what all the doom and gloom was twenty years earlier. But the people who will benefit will be Generation Z.

Ed April 4, 2012 at 11:51 am

Sorry. that was meant to be “Master of None’s” general point.

liberalarts April 4, 2012 at 8:22 pm

Permanently damaging the earnings potential of your cohort? I am not a boomer, having been born in 1965, but the inflation of this generation is the lowest ever, so we can’t blame the boomers for having inflated our savings away. The major inflation in this country was caused by “the greatest generation” who were adults in charge during the 1970s.

Bill April 4, 2012 at 10:55 am

Master, We boomers want to thank you for the Bush tax cut which you will pay for, and for your belief in its continuation.

stickywicky April 4, 2012 at 11:21 am

I am a greedy geezer, but there are always intergenerational transfers of wealth. If you look at the amortized costs of all the bennies doled out to the “Greatest Generation” (GI bill, FHA/VHA finance, social security, medicare, etc.) and compare to the taxes/SSA contributions they made you will find the same raw calculus. I am reminded of something Lester Thorow said years ago to the effect that “all economic growth is a Ponzi scheme.” You’re just to late in the scheme to reap the benefits.

Floccina April 4, 2012 at 12:31 pm

Yeah but on the other side young people today have far fewer siblings to divide the inheritance among.

Willitts April 4, 2012 at 1:22 pm

The solution was depicted in Logan’s Run, except the age 30 cutoff was a bit extreme.

The real solution is a fully funded, privately owned retirement system. It internalizes the savings decision and the risks of superannuation.

Those who love the health insurance mandate should really love mandatory private retirement savings accounts, but they don’t.

Democracies should be wary of any identifiable cohort voting themselves benefits at the expense of others, especially when the benefits aren’t sustainable.

Slocum April 4, 2012 at 8:25 am

Maybe…but I don’t remember ‘protected service sector workers’ having much trouble getting COLAs written into their contracts back when inflation was much higher. The people who would be most hurt by inflation are the savers…and ‘protected service sector workers’ don’t tend to be savers because — with very high levels of job security and defined pensions — they don’t need to be.

Matt Waters April 4, 2012 at 8:29 am

This is a very good post. In my arguments with various libertarians, there’s an assumption that deflation is the good, rightous, tough route while inflation is like a bailout. But for those with secure service sector or government jobs, deflation pushes up their real wages above already too high levels. Those outside the privaleged sectors then have to dedicate even more of their incomes to the service sector and less to other people like themselves. The unprivileged sectors have to push down their wages even further than the overall deflation would suggest.

Slocum April 4, 2012 at 9:06 am

As far as I can tell, the only time that public service sector wages do decline is when the government really just doesn’t have the money to spend (and can’t feasibly borrow any more). If there’s inflation but the government is flush, then cost-of-living adjustments on top of raises, and various other sweeteners will be forthcoming. But when the government in question is flat broke, then and only then does public sector compensation actually seem to shrink on net (and the presence or absence of inflation doesn’t matter much). For example, watch what happens in the next few weeks to the pay of ‘protected service sector workers’ in the city of Detroit when their contracts get rewritten under A) Bankruptcy, B) A state appointed emergency manager or C) A consent agreement. Inflation is irrelevant — at this point all that matters is what the city can actually afford to pay.

Matt Waters April 4, 2012 at 9:50 am

Unfortunately, there has been very little of public sector employees seeing their wages decrease across the board. Typically governments have balanced their books through first-in-first-out layoffs, which labor unions are fine with since the higher seniority workers will see their wages untouched by them.

The issue is that COLA’s only work one way and so, theoretically, the higher seniority workers will see their real wage stay the same in inflation but their real wage will increase if their nominal wage stays the same during deflation. The 2008 deflation pushed down things like gas prices far below 2007-2008 levels. Bringing the economy back to full employment will necessitate bringing gas prices back up to 2007-2008 levels and those in with job security and fixed wages will push like crazy against that, even if the general welfare is far better with 5% unemployment.

Slocum April 4, 2012 at 10:48 am

Unfortunately, there has been very little of public sector employees seeing their wages decrease across the board. Typically governments have balanced their books through first-in-first-out layoffs, which labor unions are fine with since the higher seniority workers will see their wages untouched by them.

There has been some progress in requiring public employees to make greater contributions to pension and health benefits as well as in moving new public employees into 401K style plans instead of pensions. Much more of this can be expected as the enormous public pension fund deficits bite harder into state and local budgets. Also, even if the first response has been to reduce head-count rather than compensation levels, that, too, is progress–many public sector organizations were overstaffed, and the shrinkage of bureaucratic fiefdoms is a good thing on balance.

Ryan April 4, 2012 at 8:56 am

Not to be obtuse, but when exactly do we need a money supply that greatly exceeds the demand for money? I wonder what that would look like in other markets…

“The market for our Beanie Babies is drying up, sir. What will we do?”
“Produce more! Drive their value down until people start buying them!”
“But sir… people already place a low value on our Beanie Babies…”
“Then we’d better start working ’round the clock!”

No, no… Don’t worry, folks. I get it. Money is different!

Matt Waters April 4, 2012 at 9:33 am

The difference is that, unlike other markets, new money can be destroyed very quickly. In the case of Japan, when they hit the zero-bound, they did print a lot of money. However, the market expected that Japan would sell assets (destroy money) and raise rates at the slightest hint of inflation, which is exactly what they did.

A rational market with such expectations will not do any activity betting on future inflation or NGDP growth being higher.Such activity includes things such as investing in the stock market or alternative assets instead of holding T-bills or cash. Those activities which assume those expectation in turn make sure those expectation come to pass.

Also, money supply doesn’t “greatly exceed demand.” Demand was far higher than supply in late 2008, even as the Fed printed much more supply. No classical market would see the price of a good stay the same even as the quantity of that good increases dramatically. Money is different however because the supply can also be reduced suddenly by the central bank.

Ryan April 4, 2012 at 9:56 am

Matt, yes, I understand.

Regarding your last point, inflation is generally regarded as an increase in the money supply in excess of the demand to hold it. That’s what causes prices to rise. I was kind of poking TC with regard to his comment about “supporting inflation when needed.” When do we “need” anything in excess of market demand?

Just a little snark. Carry on. ;)

ivvenalis April 4, 2012 at 9:11 am

“Perhaps we have lost the ability and the political economy to support inflation when needed.”

We’ve lost the ability and political economy to do practically anything except increase the number of people who receive free stuff. I don’t see why a social democracy would be any more capable of solving through inflation what it can’t solve through budget cuts, other than hope nobody would notice the latter against their personal interests. Which they might not have thirty or forty years ago, but fiat currency has been around long enough that everybody knows the deal now.

Shamus April 4, 2012 at 9:28 am

There are two issues here. The first is whether a stable currency is desirable. The second is rent seeking by political elites.

A stable currency supports economic activity because it allows entrepreneurs to manage their businesses more effectively. If there is an issue around currency, then hedging or some other form of risk management is required, and this detracts from efficiency.

Rent seeking on the part of political elites is obviously a drag on productive activity. The stability of the currency may impact the degree of economic damage it causes, but this is a corollary issue.

Willitts April 4, 2012 at 1:29 pm

Stable inflation expectations is the key. As long as economic actors can predict inflation with some accuracy, there won’t be much market distortion.

The efficacy of monetary policy is a separate issue.

Given a positive time preference for consumption, mild deflation is actually optimal policy because it encourages saving for the vast majority of the population with a small amount of income that can be saved. On the other hand, people who have hyperbolic discounting won’t be induced to save with any feasible subsidy or deflation. These people need to either be forced to save or forever be denied assistance in old age or disability.

mpowell April 5, 2012 at 1:33 pm

When you mean saving, do you mean purchasing government bonds or do you mean actual investment? Because deflation is terrible for investment and as far as I’m concerned, savings that isn’t invesment is basically worthless.

Rahul April 4, 2012 at 9:40 am

Finally, the one good thing about the existence of these “protected, privileged” lobbies? That they battle inflation!

Libertarians hate inflation, right?

ig'nant April 4, 2012 at 9:45 am

Would love for someone to mention what a protected service sector job is. Thanks in advance.

Matt Waters April 4, 2012 at 9:54 am

The idea applies more in Europe, especially in the periphery where services like notaries, accountants and government workers have very high barriers to entry. People on the outside think things are terrible for everyone in Italy or Greece, but the protected service workers actually do better as their wages say the same and everyone else’s prices go down due to lack of demand.

pravin April 4, 2012 at 9:52 am

so money is non neutral ? great.that is a good point to concede.now re-examine that stupid welfare enhancing dogma

Tom Grey April 4, 2012 at 10:24 am

With generous CPI based COLA agreements for most pensioners and gov’t workers, their is not much opposition to CPI “inflation” (excluding food and fuel), but there IS opposition to higher prices! especially for food and fuel (not included in many COLA agreements).
If the gov’t wages stay fixed, inflation is a good way to slowly reduce the real cos, but it’s not a big debate issue on inflation.

The Democratic Socialists who successfully demonized “tax cuts for the rich” have created a political culture of rewarding failure, mistakes, and carelessness, while punishing prudence, hard work, and success. This willingness to punish the innocent successful so as to reward the not-innocent unsuccessful dominates the ability or lack thereof to politically support inflation.

There is not a real debate about inflation. Demonization of Palin, when she opposes QE II for inflation reasons, indicates a Democratic media unwilling to openly discuss the pros and cons of more inflation. Or did I miss something?

Finally, Bush had a huge stimulus — tax cuts — which was successful. Had the pro-stimulus Democrats wanted more stimulus, rather than merely more gov’t spending (like to failing green power companies that donate to democrats), they would have been fighting for more tax cuts, including for the rich. Instead, they joined with Bush in bailouts for the speculation losses of the super rich financial industry …

There are so many interrelated other issues that it is pre-mature to suggest that we are unable to support an inflation policy that would increase economic growth; but “when needed” is far too strong. Needed by who? as compared to what? and who dies if it doesn’t happen (what, nobody dies? then why is it “needed”? Oh, for optimal growth…)

Lower taxes, less gov’t spending, slower growth, and less inflation is likely to be better than higher gov’t spending, higher (temporary) growth, higher inflation, and higher taxes.

Finally, highest paid and longest serving gov’t workers should be forced into half-time jobs to open up more starting gov’t jobs at full time — and encouraging, but not forcing, the gov’t workers to leave for non-gov’t full time jobs.

spencer April 4, 2012 at 12:41 pm

The economic expansion under Bush was the weakest on record.

If that is your idea of success I would hate to see your definition of failure.

Pat MacAuley April 4, 2012 at 10:27 am

Professor, this is a remarkable string of assertions and conclusions, but there is not a single statistic or citation in support of them. (For example, aren’t protected service workers more likely to have COLAs?)

This is not a great example of GMU scholarship. If I were your prof, ,I would give it back for a re-write.

Bob Dobalina April 4, 2012 at 12:42 pm

Dude. It’s a blog post.

msgkings April 4, 2012 at 1:14 pm

+1

Pat MacAuley April 4, 2012 at 6:57 pm

@Bob Dobalina

Are you saying that a GMU professor’s blog post doesn’t have to meet high standards? Especially a blog that is partly supported by GMU, and to a large extent reflects on GMU?

I’m a GMU alumnus (MA Econ 1986) and I’m generally proud of Marginal Revolution blog. But lately I worry that Prof. Cowen has been stretching himself too thin.

mpowell April 5, 2012 at 1:29 pm

This is exactly correct. I think that regular full-time workers without unions are the most vulnerable targets of inflation in the United States. They are the ones who have the hardest time preventing real wage cuts if the job market is soft but inflation picks up. Maybe the perception is different, but especially public sector unions do not have much to worry about (except probably academics). There are probably some retirees on fixed plans, but SS, of course, is the backstop for the vast majority and it has COLA. Western Europe I have no idea what their problem is. Maybe many sectors over there have never figured out the concept of the COLA? I think they might have some really conservative savers (and your averge saver probably can’t figure out the concept of something like TIPS). Does their SS include COLA?

Scoop April 4, 2012 at 10:27 am

Can someone point me to the best overview of inflation, one that cites the actual studies — so I know what actually underlies what we think we know — but doesn’t require econometrics that I forgot more than a decade ago?

Every natural instinct says that economists like Tyler overstate the benefits of inflation while understating the costs. How much of a drag is it on production for each worker to have to renegotiate his deal, every damned year, always battling to do better than inflation (which varies for each person, so giving everyone the same raise does not actually compensate everyone the same) while the employer battles to hold raises below inflation, every single year — rather than just having prices and wages stay the same and workers/managers producing actual value rather than haggling?

I don’t get the sense that Tyler (or any of the pro-inflation economists) considers any of those costs. But I’m willing to be convinced otherwise. Can someone point me to something that proves Tyler and the rest of them brilliant and destroys my intuitions about the costs of inflation?

FE April 4, 2012 at 10:31 am

I don’t follow. All wage-earners stand to lose from inflation. Why would those in non-protected jobs be more likely to favor inflation?

will April 4, 2012 at 1:37 pm

Their employment status and wages may be more volatile anyway – they likely re-adjust often and are much better prepared to do so.

Willitts April 4, 2012 at 1:41 pm

I don’t buy it either. I think it’s the opposite.

Public sector wages are usually adjusted for inflation either through automatic indexing or negotiated term agreements. Public sector budgeting usually accounts for inflation.

Private employers have more flexibility to use inflation as a wage cutting mechanism if they can. Private employees would favor inflation only if the gains from dilution of their debt outweighed the loss of real purchasing power from discretionary income.

The difference between the public and private sector is that private sector decision makers must answer directly to their principles (shareholders and suppliers of capital). Public sector decision makers are insulated from their principles (taxpayers and voters).

Unless there is an effect between defined benefits and defined contribution pension plans, I don’t get it.

quadrupole April 4, 2012 at 11:07 am

FE – Workers in competitive positions will tend to see their wages increase to keep up with inflation. Workers who are overpaid (usually due to wage stickiness or being in protected industries) generally *won’t* see their wages increase.

FE April 4, 2012 at 5:17 pm

Sorry, still don’t follow. Protected workers have the power to overpay themselves in times of low inflation, but inflation negates that power? I’d like someone to explain why the power of protected workers to demand above-market wages would be inflation-dependent.

CG April 4, 2012 at 11:24 am

The economics of this post may be right, but the political analysis is way off.

First, for an increasing number of citizens in protected service sector jobs to actually oppose inflation, they need some sort of idea of whether it would be good or bad for them. This is an optimistic assumption about the economic literacy of American citizens. I’m skeptical that most citizens (including “privileged insiders”) are informed enough to know that it may be in their personal interest to oppose inflation.

Second, when Joe Schmoe thinks of his salary, he thinks about what he can do at the workplace to get a pay increase, not about the inflation rate. Even if one makes the unrealistic assumption that he does think about inflation, the connection is so remote and other factors are so much more influential on how much he gets paid, that he probably doesn’t care that much about it.

Third, central banks are largely insulated from popular political pressure. These aren’t popularly elected officials or even easily removable ones. Central banks have little incentive to be responsive to the demands of “privileged insiders.” Their relative independence and the clear, measurable goals provided for them ensure that they are more technocratic than political.

Ranjit Suresh April 4, 2012 at 1:54 pm

This is exactly right. I would add that if it can be shown that there is greater support for inflationary measures among the young and those working in unprotected labor sectors and significantly less support among older workers and protected sector employees, then Cowen’s analysis may be accurate. On the face of it, given near universal economic literacy, it’s likely central banks are the more powerful force driving monetary police than greedy public employees and credentialed professionals.

Yancey Ward April 4, 2012 at 1:50 pm

Resorting to inflation is socialization of bad economic behaviors. The real question is- welfare-enhancing for who. The common argument is that inflation helps debtors in favor of creditors, but that is simply wrong in a legal system with bankruptcy laws and no debtor prisons. Debtors can always default leaving the creditors with nothing but the collateral when there is collateral. Inflation helps keep debtors on the hook longer. It really is an amazing feat convincing debt slaves that continuing to pay is the welfare enhancing route for them. Really, if inflation were to the benefit of the vast majority of us, shouldn’t the Federal Reserve resort to actual helicopter drops into every citizen’s bank account on a per capita basis?

Bill April 4, 2012 at 5:39 pm

Well, I can see how tenured GMU faculty might worry about this.

Benjamin Cole April 4, 2012 at 7:18 pm

Also the bondholding class wants no inflation. This is a good post.
Add on: central bankers and their staffs generally have sinecure. They would prefer stable prices and tepid growth to robust growth and some inflation.

Adam April 5, 2012 at 6:12 pm

Why? With the latter, wouldn’t the be in a better position to renegotiate?

Adam April 5, 2012 at 6:11 pm

I don’t think I follow. What’s a protected service sector job, and what about inflation makes people with those jobs fear renegotiation?

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