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Nick:

If we are really talking about the minimum wage, the macro effects are small compared to the microeffects--low cost of unskilled labor, lower relative prices for the products of unskilled labor, and the like.

It seems to me like there are some folks that are assuming that wages earned by current minimum wage workers are a significant portion of total income (rather than some tiny fraction,) and that wages paid to minimum wage workers form a larger fraction of total costs, so lower minimum wage will create a roughly proportional decrease in the price level.

It would be like imagining that all workers earn the minimum wage. Come on!

I can understand why people want to think about perfect wage and price flexibility and roughly proportional drops in the levels of wages and prices, but it is so distant from cutting the minimum wage under current conditions.

From:

http://blogsandwikis.bentley.edu/themoneyillusion/?p=3265

"In fairness to Eggertsson, he understands that there are a lot of qualifiers in his model. This is from the first paragraph of his conclusion:

The main problem facing the model economy I have studied in this paper is insufficient demand."

How about emphasizing insufficient demand IN THE PRESENT (as in a time period)?

Bill: OK. If less than 10% of workers would be directly affected by a cut in the minimum wage (probably roughly right for Canada), the macroeconomic effects are maybe not large. But we ought to be able to understand what those macroeconomic effects would be, in any case. To my mind, thinking in terms of raising or lowering minimum wages is just a convenient thought-experiment whereby we can consider a purely exogenous change in nominal wages.

Too much Fed: "How about emphasizing insufficient demand IN THE PRESENT (as in a time period)?"

But that's what he IS talking about. And that's what every economist will understand him to mean. ?

Nick's post said: "Too much Fed: "How about emphasizing insufficient demand IN THE PRESENT (as in a time period)?"

But that's what he IS talking about. And that's what every economist will understand him to mean. ?"

If there is insufficient demand in the present, then why do almost all economists insist on using currency denominated debt (future demand brought to the present) to address the insufficient demand in the present?

The Rajiv Sethi link is excellent.

I like the McDonald's example. Now apply that to labor markets where the minimum wage does not apply.

Are there any links between the labor market, whether an economy is demand or supply constrained, and the fungible money supply?

Re: 2, I wonder the same thing, both about Japan, and about demographics potentially being key (in some manner we don't fully understand yet).

Re: 3, Large banks generally have sophisticated models for stress testing their portfolios (in fact this is a core requirement of Basel 2). State of the art models that I've seen generally try to use statistical methods to decompose variation in losses into components due to changing maturity profiles of the exposures, changes in macroeconomic conditions, changes to lending standards / exposure quality and idiosyncratic factors (i.e. other). Generally you'd let the model decide which macroeconomic factors were relevant based on the data. You need a lot of data to do this and the fact that the leaders in this area were the U.S. banks, many of whom ended up effectively bankrupt doesn't inspire a lot of confidence, but my understanding is that at many banks the models foretold the sort of problems that ended up happening (given a stress scenario) but nobody really believed the stress scenario would come to pass so nothing was done. As you say, figuring out which scenario might actually come to pass (i.e. predicting the future) is the really hard part.

Given the comparatively advanced state of stress testing in the industry it's surprising to see the Bank of Canada applying such a simplistic, static, single case analysis. Maybe they are short on resources (but they can print money after all! :) On a more serious note, I found it worrisome that, given what just happened in the U.S., the Bank of Canada would explicitly exclude mortgages from its stress test based on an assumption that there will be no significant decline in housing prices. I mean, if you had to identify one assumption that directly led to the U.S./global financial meltdown, it would have to be 'housing prices always go up', and here the Bank of Canada - not in a forecast, but in a *stress test* no less, continues to assume that in Canada, we are immune to a significant housing downturn. It's a bit baffling, to be honest.


Finally, and off topic, my uninformed impression of recent events is that Carney would like to pop the housing/debt bubble, but doesn't want to raise rates with the dollar high and inflation low, so he is trying to pressure the government into taking specific actions to rein in debt (i.e. tighten lending rules, stop routing so much money through CMHC, etc.), but the government is basically ignoring him (publicly, at least). That's all pure speculation on my part, of course, I'd be interested to know if you guys (Stephen and Nick) see it the same way.

Nick:

In the U.S., it was 2.3% of workers earned the minimum wage or less in 2007.

Wages make up 66% of income.

If all workers had equal wages, a 10% cut in the income earned by minimum wage workers would have reduced total income by .15% But this is a huge overestimate.

A full time minimum wage worker is in the bottom 20% of income earners in the U.S. They earn 4% of total income. If we assume that all minimum wage earners are in households in the bottom 20%, then mimimum wage workers make up 5% of that bottom fifth. If their incomes drop 10%, and that reduces income of the bottom fifth, then that would be a .02% drop in income.

The effect of a lower real wage on aggregate income is trivial.

If the demand for unskilled labor is inelastic (and I think it is) then what happens is that the lower wages do result in lower prices for the products of unskilled labor, (say, hamburgers at fast food joints,) the result is lower prices for those products, and an increase in quantity demanded. But the reason the demand for unskilled labor is inelastic will mostly be that the demand for those products are inelastic.

But that leaves more real income for those buying the products to pruchase other things. OF course, this effect is tiny as well. How much do the product prices fall. How much do households spend on products that use unskilled labor.

Krugman argues (and this is your implicit argument as well) that the only way total employment could expand (as opposed to the employmnet of those unskilled workers facing 57% unemployment,) is for lower average wages to expand total employmnet.

However, the micro approach does a better job in showing this. It is the subsitution effect. The lower prices for the products of unskilled labor (though we can imagine changes in the production process too, I suppose,) results in a substitution out of other goods and lower demands for the labor used to produce those goods.

But for there to be a decrease in demand in the rest of the econmy, it would require that the demand for unskilled labor be elastic. If it is unit elastic, total real demand in the rest of the economy is unchanged. If it is elastic, it falls in the rest of the economy.

It is probably inelastic. That means that the total income of unskilled workers drops, but more unskiled workers are employed. Total demand in the rest of the economy rises.

As for these hike the minimum wage and create expected inflation stories, well, you have th same problem. You are increasing wage cost by some tiny bit. I know my students are willing to believe that a 10% minimum wage raises the price level 10%, so with stupid enough people, maybe.

I think the problem is that macroeconomists are too model oriented. The model has "the" interest rate, "the" wage rate, "the" price level. Like you said, you naturally plug in a hike in the minimum wage into an implicit model where "the" wage increaes.

This issue has been very serious lately because of "the" interest rate. "The" interest rate is nearly zero. Well, the reality is that _some_ interest rates are nearly zero. Thinking about an economy where there is one interst rate and what would happen if it were near zero doesn't tell us too much about a real world where there are lots of interest rates and nearly all of them are well above zero.

Too much Fed: "Are there any links between the labor market, whether an economy is demand or supply constrained, and the fungible money supply?"

Well, that's one of the things everyone has been arguing about for the last year: can monetary policy increase demand for goods and thereby increase demand for labour? Normally 'yes', but when interest rates are near zero?

Declan:
You make some very good points there.

In defence of the BoC, they are trying to do stress tests on households, and only indirectly figure out the implications for banks. When banks do stress tests, do they look at households? Or do they start with the assets on their balance sheets?

But I admit my eyebrows raised a little too when I saw the BoC stress test essentially ignored house prices. Their argument is that all the high LTV ratio mortgages are CMHC-insured anyway, and it's unlikely that the lower LTV ratio mortgages would default, and if they did default the bank could sell the house and recover its loan. So, as far as I can tell, their results must be driven by other forms of household debt, not home mortgages. Credit cards? Car loans? I do wish they had given more details about their data and method.

On your last "off-topic" point (but I say it's on-topic, especially on a rambling post like this): I had not thought of that at all. My guess had been that Governor Carney was speaking directly to the people, warning them to "be careful now!". I'm sure if he wanted to get the government to tighten the rules, he would be telling them in private. The public declarations might be to add pressure to the government, as you say. Or it might be to prepare public opinion to support the government in tightening the rules? Interesting thought, anyway.

Bill: I totally disagree with your approach to analysing this question. (It's rare we disagree so totally on theory!)

"The effect of a lower real wage on aggregate income is trivial."

My initial starting point would be to say it's not trivial, but zero. All it does is change the distribution of income. Then I would look to see if there were any indirect effects on aggregate demand. The effects on aggregate demand of a trivial change in the distribution of income would be doubly trivial. I would be looking for any effects it might have on monetary disequilibrium, via real balance effects, monetary policy, and investment demand.

Whether the demand for minimum wage labour is elastic or inelastic (effect of price on total revenue) is theoretically irrelevant, I would say.

Maybe I ought to do a post on this. Because the micro-oriented approach that you, Tyler, and Brian are following is, I think, totally misguided.

"And why did the price level rise in the 1930's, when recovery started, even when output and employment were still a long way below potential?"

Competitive devaluations moving off the Gold Standard.

My answer on knowledge of the Great Depression is more complicated, as an outsider it seems that economists aren't very good historians, in part because of the Great Depression. There is a tendancy in economics to view history as two periods; 'normal' and the 'Great Depression.' Consequently, economists tend to either ignore it or concentrate on studying it as a singular event unrelated to every other financial crisis (Sumner, Bernanke).

So, was Japan a warning? Yes. So was the Asian financial crisis and Sweden's, and every other financial crisis, including the Great Depression. It was terrible, but not as special as economists have liked to think.

"Climate scientists aren't as lucky. They are still arguing about whether there was a Medieval Warm Period, whether it was global or local, and whether it was as warm then as in the recent warming."

http://www.realclimate.org/index.php?s=medieval+warm+period&qt=&q=medieval+warm+period+site%3Awww.realclimate.org&cx=009744842749537478185%3Ahwbuiarvsbo&client=google-coop-np&cof=GALT%3A808080%3BGL%3A1%3BDIV%3A34374A%3BVLC%3AAA8610%3BAH%3Aleft%3BBGC%3AFFFFFF%3BLBGC%3AFFFFFF%3BALC%3A66AA55%3BLC%3A66AA55%3BT%3A000000%3BGFNT%3A66A%5C%0D%0AA55%3BGIMP%3A66AA55%3BFORID%3A11%3B&searchdatabase=site#1275

Re: 5, "Why has there been so little deflation: in Japan; in the 1930's, and in the last year?"

I'm an American, so my knowledge is pretty much limited to the US experience, but the stylized fact that I recall from graduate is that in 1930s is that the US price level fell by about 25%, overall from 1929 to 1933 (confirmed by the calculator at http://www.minneapolisfed.org/). Food prices, as I recall, fell by about a third. Manufacturing wages fell by nearly 25%, so a worker who managed to remain employed actually enjoyed higher real wages in 1933 than 1929 (assuming away any nominal debt, etc.)

oops: "that I recall from graduate is that" s/b "that I recall from graduate school is that"

On the minimum wage:

Why is it assumed that cutting the minimum wage would necessarily reduce income for all those currently employed at the minimum wage? Presumably, those currently employed at the minimum wage are employed because their productivity justifies it. Those whose productivity would justify employment at a lower wage but not at the minimum wage are not hired. I am not sure that labour, even unskilled labour, is a homogeneous commodity.

If it's not a good idea to cut the minimum wage, does that imply that it would be good idea from an AD perspective to raise it? If not, why not and does that mean that the minimum wage was too high before the onset of the recession? If so, should we reduce it when the economy recovers?

Should we hold the price for other factors of production above the market prices as well on the basis of the effect that price adjustment would have on the incomes of the providers of those factors or the related aggregate demand impacts?

From a broader perspective, does promoting economic efficiency, via market clearing, not also generally promote aggregate demand and economic growth? In a related vein, Keynesian-types (new, neo and paleo) argue that, due to downward price and wage stickiness, we get falling output and rising unemployment. One might naturally assume that one of the remedies implied by such thinking would be to reduce policy-induced price and wage rigidities. But apparently not.

Mark: "Competitive devaluations moving off the Gold Standard."
That may be the reason why the price level rose. But it conflicts with the Phillips Curve story, which says that we should not see inflation until output gets above potential.

OGT: "... as an outsider it seems that economists aren't very good historians,..."

True for most of us, I think. In my case, history was the only subject I failed in school. I actually enjoy reading history, and think it's important too. I'm just bad at it. Too much stuff to remember. That's (one of the reasons) why I'm an economist.

marcel: yes, prices fell during the depression. But why didn't they keep on falling, at an ever-increasing rate? That's the puzzle.

David: I think I'm going to have to do a post on money wages and employment, an address all these questions there.

1. What would it be like if we had better data from the 19th century? It would go a long ways toward making the Great Depression less one of a kind.
2. Yes it was a warning, one widely dismissed. Demographics plays a part, but no doubt an unwillingness to inflate also does. Without monetary intervention, a growing market of elderly consumers should lead to inflation if they consumed at the same rate as while working since there are fewer producers.
3. NC
4. I am not that persuaded by Sumner's data. That the immediate effect of wage increases lowers industrial production growth as it hits profits seems obvious until price increases can be passed along and made to stick. That it should also increase demand for productivity improvements and did so during this period also seems obvious. That it raised inflationary expectations also seem obvious. Whether lower employment growth at higher wages and higher productivity lowered gdp relative to what it would have been without these policies, not at all.
5. Wealth, in liquid assets and income producing assets, would tend to put a floor under consumption. Wage policy in the 30s probably had an effect. Did prices rise as much in Canada as the US then?

Nick: US in 1930s did not have automatic stabalizers. AND it was on gold standard. Hard for deficit to go up.

Not the case here. If Japan had not deficit spent, deflation would be much much nastier there instead of this long term grind that's been crushing it.

The labour market is so different today that I wonder if it's really a valid comparison.

Why haven't we fallen into a deflationary black hole (at least no yet)? Could it be as simple as central banks managed to save our tails? I suspect that without all the extraordinary programs - the Fed's commercial paper intervention and money market guarantee in particular - we really would have crossed the event horizon. In the fall of last year I remember hearing interviews on Bloomberg radio with guys working in commercial paper, and they were terrified. The very fact that someone working in CP was considered a 'get' was right out of the twilight zone.

Nick's post said: "Too much Fed: "Are there any links between the labor market, whether an economy is demand or supply constrained, and the fungible money supply?"

Well, that's one of the things everyone has been arguing about for the last year: can monetary policy increase demand for goods and thereby increase demand for labour? Normally 'yes', but when interest rates are near zero?"

I believe that the phrase monetary policy should be junked. Can lower interest rates continually sucker the lower and middle class further and further into currency denominated debt to the rich if most of the labor market is oversupplied and most of the goods/service market is oversupplied?

zanon said: "Nick: US in 1930s did not have automatic stabalizers. AND it was on gold standard. Hard for deficit to go up.

Not the case here. If Japan had not deficit spent, deflation would be much much nastier there instead of this long term grind that's been crushing it."

So when a currency denominated debt bubble bursts, do you want your recession hard and fast or long and drawn out?

Mark said: "'And why did the price level rise in the 1930's, when recovery started, even when output and employment were still a long way below potential?'

Competitive devaluations moving off the Gold Standard."

Nick said: "Mark: "Competitive devaluations moving off the Gold Standard."
That may be the reason why the price level rose. But it conflicts with the Phillips Curve story, which says that we should not see inflation until output gets above potential."

What happened to reserves when the USA went off the gold standard?

If Japan needed to inflate, why did the government borrow the money to run deficits rather than just print Yen? At this point, why does the government not just print yen, and repay its debts/buy back its bonds? This could help to stimulate inflation, which is needed.

What am I missing?

Andrew F, there might be a reason they do not want to print currency that involves wealth/income inequality.

Nick: "That may be the reason why the price level rose. But it conflicts with the Phillips Curve story, which says that we should not see inflation until output gets above potential."

I'll admit I've been out of school for awhile, but I'll give my take.

Moving off the GS was basically a commitment to higher inflation, like the BoC coming out and saying '2% stinks, lets go higher'. Even with an economy operating below potential, these higher inflation expectations should increase inflation, especially in a country recovering from an asset bust.

There were something other things, like money hoarding/zero rates/MASSIVE unemployment. Committing to higher inflation to partially tap these sources of potential growth could result in sustained real growth.

Agricultural mechanization must have played a part in the high levels of unemployment during the depression. Lots of jobs disappeared, never to return. There's a parallel with the current situation in the US. Lots of jobs in finance and RE (and not so long ago in IT) have disappeared never to return.

Nick: I agree that the claim that Japan was (liquidity)trapped is puzzling. As you say, we didn't see the rate of deflation *decreasing*. And, what would have gone along with that, a *deepening* recession as the lower bound on the real rate continued to rise. I'm beginning to wonder whether people aren't trying to make the ZIRB do too much work. A decade-long stagnation seems to call for a model with multiple equilibria in real output. That has always seemed to me a better way of thinking about what Keynes was up to. Unfortunately, I don't have such a model!

Kevin: Yes, maybe a multiple equilibrium model would be better. But I can't think of (a good) one either.

Patrick: I read a blog post recently where someone (Brad DeLong?) dumped on that idea. I can't remember his argument against it. Part of it was that the loss of agricultural jobs was very slow and steady; and it was industrial employment that suffered most, I think.

Mark: we can always make an expectations-augmented Phillips Curve fit any set of facts if we can assume whatever we like about expected inflation. But is it plausible?

Andrew: "What am I missing?" I don't know. But whatever it is you are missing, we are all missing the same thing!

Nick, you might want to check out this link titled "The Real Great Depression" by...

Scott Reynolds Nelson is a professor of history at the College of William and Mary. Among his books is Steel Drivin' Man: John Henry, the Untold Story of an American legend (Oxford University Press, 2006).

http://www.itulip.com/forums/showthread.php?p=52465#post52465

It talks about whether the current situation is more like 1873 than 1929.

Here is one quote.

"But the economic fundamentals were shaky. Wheat exporters from Russia and Central Europe faced a new international competitor who drastically undersold them. The 19th-century version of containers manufactured in China and bound for Wal-Mart consisted of produce from farmers in the American Midwest. They used grain elevators, conveyer belts, and massive steam ships to export train loads of wheat to abroad. Britain, the biggest importer of wheat, shifted to the cheap stuff quite suddenly around 1871. By 1872 kerosene and manufactured food were rocketing out of America's heartland, undermining rapeseed, flour, and beef prices. The crash came in Central Europe in May 1873, as it became clear that the region's assumptions about continual economic growth were too optimistic. Europeans faced what they came to call the American Commercial Invasion. A new industrial superpower had arrived, one whose low costs threatened European trade and a European way of life."

That does look like an interesting comparison. I do wish I were better at history. But I couldn't even finish Neill Ferguson's book on money. I need the version for Dummies.

I think it was DeLong. Agriculture was in depression after WWI and the 20s were a time of great mechanization when people left farms and moved to towns and cities. Most had housing booms in the 20s as a result. The depression slowed this if anything since people could at least subsist growing their own food.

"Why, in other words, do we sometimes see a relationship between the price level and output, and at other times see a relation between the rate of change of the price level, and output?"

I'm actually working on this now, should have something in a few weeks, I hope it will be epic.

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