Month: December 2009

Many bloggers are commenting on Bernanke's response to Brad DeLong's question about whether the Fed should target three percent price inflation to stimulate aggregate demand and lower unemployment.  I'll offer two points:

1. We no longer have an independent central bank in this country, at least not for the time being.  There is no particular reason to think current monetary policy is Bernanke's personal decision, most of all because he is up for reappointment.  He may well know better and arguably his remarks signal as such.

2. I still favor a two percent target (three would be fine too) for the rate of price inflation today.  But it matters when we implement such a policy.  The longer we wait, the more we miss out on its potential benefits.  For instance it's easier for AD-robust market conditions to signal to employers not to lay off workers than it is for market conditions to signal that workers should be rehired.  The longer we wait, the more the inflation (and its expectation) loses its potency.

Furthermore nominal wages adjust sooner or later, even if the downward ride is a bumpy one with some negative cumulative spirals along the way.  I don't personally think we are close to the point where three percent is a bad target but that's a guesstimate rather than based on hard science about the state of the labor market this spring.  In any case three percent will become a bad idea at some point and we need to start asking ourselves when, no matter how good an idea it was a year ago.

According to Katz, payment for driving on the route will be based on a fluctuating fee depending on the levels of traffic – the more traffic, the higher the fee. While ministry officials say that the minimum toll for traveling on the route would be NIS 5, the maximum price is still unclear. In any case, the drivers will only know the price of the toll shortly before deciding to use it. According to the plans, a modifiable electronic sign 1.25 km before the onramp will display the price drivers will be charged depending on the levels of traffic.

Here is more and I thank Adrian Lucardi for the pointer.  The road owner is supposed to guarantee an ongoing speed of 70 kph or better.

1)  A fall in wages
increases the incentive to hire (call this the substitution effect) but it
decreases the income of people who already have jobs and this in turn
decreases their spending and other people’s income (call this the macro income effect).  In essence, Krugman and others are arguing that the macro
income effect can dominate under certain situations.  See Tyler (here and here) and Scott Sumner (Whom I cannot resist quoting–"no respected macroeconomic theory has ever been so decisively refuted
by the data as the theory that high wage policies can actually help the
economy during a Depression") on this point.  I, however, will ignore this debate and take it as given that this is possible.

Now one reason that people are talking about
a cut in the minimum wage in this context is that it follows exactly the two-part logic given above.  But bear in mind that the real policy choice
we have is to cut the payroll tax and cutting the payroll tax increases the
incentive to hire and increases the income of people who already have jobs.

2)  The idea of the
liquidity trap with its notion of lack of movement, inactivity and firms which "just aren't hiring" is hard to reconcile
with the fact that millions of new jobs are being created every month.  I have said this before but I should have shouted it from the rooftops because this error is very common.

Casey Mulligan's post, on the liquidity trap argument, is spot on.  Here's another simple thought experiment.  Let's say that, for reasons of technology, currency disappeared.  All transactions would be made with POS or cell phones, backed by interest-bearing assets, in one form or another.  You might think that's unlikely today but it's at least possible in the future.  In any case, it's a thought experiment.

In this world there would no longer be a trade-off between currency and interest-bearing assets, as we find in traditional Keynesian models.  There would be no substitution out of one and into the other and there would be no swapping of currency for interest-bearing assets.

What would the macroeconomics of this world be like?  Would the AD curve slope upwards?  Would increases in employment be contractionary?  No and no.  It would only be slightly different from our current world, a point Kroszner and I made in our book Explorations in the New Monetary Economics.  It just doesn't matter that much if you pay for your retail transactions by leaving a five on the counter or by using a credit or debit card backed by interest-bearing assets.

Liquidity trap arguments are themselves a kind of trap.  The theorist finds one situation where the traditional marginal equality between various rates of return is disrupted and people stand at a corner for one of their portfolio positions, namely cash vs. interest-bearing assets.  The model then has consistency requirements, in the form of interrelated mathematical equations, which "spread" the counterintuitive results across the entire economy.  But that's assuming the model is a more powerful description of reality than it actually is.  It's better to side with common sense instead.

Addendum: Arnold Kling offers related comments.

Krugman offers a response to a few critics, including I believe myself.  His latter two points are on the macro model, his first point is trying to establish the relevance of the macro model for the minimum wage analysis:

1. Why did I go from minimum wages to overall wages? Clearly, a cut in minimum wages –which only apply to some workers – can raise the employment of those workers at the expense of other workers. But the advocates of a cut are claiming that they can raise overall employment. The only way that can happen is if a reduction in average wages raises employment.

There is a simple story here.  Lower the minimum wage and firms with market power will in general hire more labor.  (Sethi's critique refuses to consider that mechanism but simply shift the MC curve and watch it happen.)  In the most straightforward setting the total wage bill increases, even if the average wage falls.  With a higher total wage bill, there is no downward deflationary spiral.  This general equilibrium point was emphasized by Jacob Viner in his very careful 1937 review of Keynes but it remains a neglected insight.

The negative scenario, namely the total lower wage bill, can possibly occur if employers use the lower legal minimum wage to lower wages for currently employed workers who were at the previous minimum.  A few observations here:

1. Even then the net effect is indeterminate and not necessarily in the Keynesian direction.  The total wage bill still could go up or even if the total wage bill goes down the total flow of purchasing power need not decline, given that employers just don't sit on their extra money.  (This same point applies to all other second-best scenarios.)

2. The model already has assumed short-run wage stickiness, so it would be odd to suddenly relax that assumption as a way to get the total wage bill to fall.  

3. Given that minimum wages don't cover so many workers, the AD effects are likely quite small in any case.

4. The new workers may well be collecting EITC, which will strengthen any aggregate demand effect from their employment.

5. The increase in aggregate supply — more work goes on! — itself has a positive effect on aggregate demand through subsequent Hutt-like, supply-side multipliers.  It would be unusual if velocity shifts were completely neutralizing with respect to this increase in production.

6. The "then why don't we raise the minimum wage to $30 an hour" meme is an overrated "right-wing talking point" in a lot of policy debates.  Still, in this context, it remains a good question from a purely analytical point of view.  Such a change would not boost aggregate demand in most plausible models and from that admission you can work backwards.

Mixing up average wages and the wage bill is a common Keynesian confusion; they're not always moving in the same way, though they may seem to in some very simple models.  Krugman's #1 is assuming a link between the micro and macro change that simply doesn't have to be there.  

That all said, it's a fair enough point to note that changes in the minimum wage will likely bring only small positive effects in any case.

Yes.  Bryan Caplan has the answers:

Paul [Krugman] does address the real balance effect, but he still ignores the main arguments I've made before:

1. Cutting wages increases the quantity of labor demanded.  If labor demand is elastic, total labor income rises as a result of wage cuts. 

2. Even if labor demand is inelastic, moreover, wage cuts reduce labor income by raising employers' income.  So unless employers are unusually likely to put cash under their mattresses, wage cuts still boost aggregate demand.

An even simpler way to explain it: Imagine every firm divided its existing payroll between a larger number of workers.  How is that bad for aggregate demand – or anything but good for employment?

P.S. If you prefer specific facts to textbook arguments, see Scott Sumner's legendary Table 12.2 on wages and the Great Depression.

As Bryan titles his post: "Cutting the Minimum Wage Really is Good for Aggregate Demand."  The actual arguments in Krugman's blog post concern an overall downward spiral in wages and prices, not minimum wage cuts at all.  The chance that minimum wage cuts set off such a spiral is very, very small.  Krugman's third paragraph makes perfect sense but the fourth paragraph and onwards is simply discussing a different topic.

I would add two points.  On Bryan's #1, workers at the current minimum wage are unlikely to receive nominal wage cuts if the minimum wage were lowered, for the usual morale and efficiency wage and lock-in reasons.  So the chance that total labor income rises is very high.  Second, no I don't believe in an upward-sloping AD curve, but in any case multipliers from production increases plus wage bill increases are likely to be more potent than multipliers from aggregate demand increases alone.

Addendum: Will Wilkinson offers relevant comment.