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He wrote:

Some prices and wages are set too high, thereby damping demand for output and for the workers needed to produce it. This is the standard sticky wage and price explanation for our economic malaise offered by Keynesian economists such as Paul Krugman and James Galbraith. I think there are fewer markets suffering from this problem than Krugman and Galbraith do, but there are enough such markets to make the case for government intervention. Indeed, the president should put these economists in charge of identifying the markets suffering from this problem and helping their participants set market-clearing prices and wages.

Via Mark Thoma, Jamie Galbraith objects to his cited role, and Paul Krugman piles on.  Three points:

1. Call me strange, but I read Kotlikoff as being sarcastic in this passage, especially in the last sentence, objecting to the pretense of knowledge which he sees as embedded in some extreme forms of Keynesian doctrine.  To respond to this criticism with a straight yet outraged face is to miss the joke and arguably at the same time to validate it.  Kotlikoff is not actually suggesting that Krugman and Galbraith rule a new wage and price commission (surely that proposal and its specificity is the giveaway, no?), or implying that Krugman and Galbraith see price flexibility as the answer to our macroeconomic problems.  He may, though, be wondering why they do not, which brings us to:

2. The “New Old Keynesians” repeat the Great Depression point that lowering wages will be destabilizing.  During the Great Depression, there was a large negative nominal shock, nominal wage reductions for a broad swathe of the employed labor force in response, and a downward spiral of wages and prices, at least for a while.  Fair enough, and one can model that coherently.  Today we are talking about trying to lower reservation wages for 2-4 percent of the wage force, namely some of the currently and non-naturally unemployed.  That is with a central bank which has set a fairly credible floor on nominal values.  To criticize these targeted (potential) wage cuts by citing the Great Depression, or relevant models thereof, is a non sequitur.  In fact it’s hard to find a good argument against such proposed targeted cuts; the best response is to cite excess capacity and claims the cuts won’t work but then they won’t lead to harm either.

3. Kotlikoff’s subsequent explanation of his stickiness point is on the mark and is not contested: “One example [of a stickiness] is the market for construction workers. A 1931 law called the Davis-Bacon Act effectively requires contractors using federal money to pay union wages. If the act were suspended or repealed, federal spending on much-needed infrastructure projects could create a lot more jobs. ”

4/5 of Kotlikoff’s piece is good.  I don’t like his idea of “…assembling in one room the CEOs of the largest 1,000 U.S. companies and getting them to collectively pledge to double their U.S. investment over the next three years.”  Does everyone have to double?  Relative to what benchmark?  What about the companies which are losing money or going under?  What happens if a company breaks its pledge?  Are they allowed to fly their private planes to the meeting?  Do those with the biggest pledges get to sit next to the President?  And so on.  In the longer run, I don’t think it helps to politicize investment decisions.

Read the whole post by Russ, but here is one excerpt:

So my challenge to Tyler is to tell me what he thinks the stagnation in median income signifies. Has there been a change in the returns to education or creativity? Or is it mostly a statistical artifact? Whichever answer he gives, I would like to see him reconcile it with the panel data–the surveys of economic information that follow the same people over time.

I will put the rest under the fold…Russ makes points about household size and immigration and there are brief mentions of CPI bias and rising benefits.  A few responses:

1. I discuss household size in the footnotes to TGS.  Adjusting for it doesn’t make a huge difference and furthermore the rapid-median-income-growth 1960s were a time when household size was falling quite rapidly.  I blogged some of the details here.

2. Immigration doesn’t seem to shift the median enough to create an illusion of stagnation, I blogged the numbers and details here.

3. CPI bias has likely fallen over time, which will make the true median income growth differential over time even greater than the numbers indicate.  Furthermore CPI measures are getting better over time and doing more to adjust for quality biases; that’s further bad news.  Most of all, a lot of CPI bias is offset by ‘wasteful spending on health care, education, defense, and government yet all counted in gdp” bias.

4. Russ doesn’t mention the internet but it’s getting more monetized — and thus more counted in gdp — all the time.  The consumer surplus of the unpriced parts, once you eliminate double-counting, probably isn’t much more than two percent of income.  Not “two percent growth a year” but two percent period.  I could see it being three or four percent, for sure, but that still won’t overturn the basic slowdown.

5. Rising household debt and abysmal job creation since 2000 suggest to me that the quantity data are in line with the incomes data.  Around 1999-2000, stagnation suddenly becomes much worse.  The only good years since then are the bubble years, whereas across 1973-1998 there are some truly good economic years (partially offset by some very bad ones).

6. 1995-1998 are a poster child for what a non-stagnating period should look like in terms of wages and median income.  Lots and lots of years since 1973 don’t look anything like that period.  When the growth is real, it shows up in all of the standard numbers and no mystery variables or invocations of biased measurements are needed.  I find this comparison illuminating.

7. I discuss benefits in the book, for the time being I’ll note a) cradle-to-grave private sector jobs, with union-based pension benefits are rarer than they used to be, b) fewer people get health care through their jobs than used to be the case, c) most of the benefits are health insurance but don’t fixate on the size of the expenditure, rather consider that health progress has been slowing down, and d) last year health insurance costs rose by nine percent and no way should that be interpreted as equivalent to an increase in real income, rather it is a sign of system failure.  That all said, the text of TGS still leaves room open for a world where virtually all of the benefits of economic growth accrue to the elderly.  Such a world still will have a lot of TGS properties.

8. Consumption data often selectively focus on the commodities which have become much cheaper (e.g., flat-screen TVs) and ignore the growth in debt, which now must be paid back.

9. The 2000-2011 case for stagnation is stronger and clearer than the 1973-2011 and there also has been more growth along the latter and longer period of time, plus numbers are easier to interpret across shorter time stretches.  I will ask Russ if he at least can buy into TGS for the last eleven to twelve years.

I don’t see panel data as offering a significantly different story from the above but if Russ tosses me a specific citation I will consider it.

On the Conover critique of income stagnation, Karl Smith is devastating.  On all the general issues, Arnold Kling comments.

Going back to the Russ excerpt above, I don’t think we should reify median income statistics or give them a final ontological meaning; they are tools.  The slow growth in the measured median, or zero growth since that late 90s, strongly suggests that something is seriously wrong with the real economy.  That slowdown seems robust to the standard attempts to explain it away.

I don’t dismiss Arnold Kling’s factor price equalization hypothesis, but still the question remains why we haven’t kept leapfrogging ahead of our competitors, as we had done in earlier decades.  We’ve become much more of a sitting duck and that will make Samuelson-Stolper effects stronger if you are the world leader on the technological frontier.

On Russ’s other query, there has been an ongoing change in the returns to education.  Note the recent study that over the last decade only Ph.ds, MBAs, JDs, and MDs have seen real income gains; even individuals with a Masters degree are getting whacked.  One way of reading those numbers is that the workers with lower educational credentials are getting less “manna from heaven” in the form of new innovations cascading into their laps.  On top of that, there is more rent-seeking in the economy and many jobs require stronger cognitive skills than in the past.

From Macroresilience:

As Minsky has documented, the history of macroeconomic interventions post-WW2 has been the history of prevention of even the smallest snap-backs that are inherent to the process of creative destruction. The result is our current financial system which is as taut as it can be, in a state of fragility where any snap-back will be catastrophic.

Taleb and Blyth write:

Complex systems that have artificially suppressed volatility tend to become extremely fragile, while at the same time exhibiting no visible risks. In fact, they tend to be too calm and exhibit minimal variability as silent risks accumulate beneath the surface. Although the stated intention of political leaders and economic policymakers is to stabilize the system by inhibiting fluctuations, the result tends to be the opposite.

Hat tips go to Nick Rizzo and Andrés Alonso and another MR reader.