The political economy of nominal wage targeting

WARNING: if you are not a macroeconomist you may not understand this post, even if you think you do. This is especially true if you are not a macroeconomist but think you know something about "political economy". (When I hear the words "political economy" I usually reach for my shovel.*) This post is an experiment. You, the reader, may be part of that experiment.

This post is partly about mutual incomprehension between macroeconomists and non-economists. But it's written mainly for an audience of macroeconomists. So stop and think before you come out swinging wildly in the comments.

This post is in two (OK, three) parts. The second part is about likely reactions to the first part, and is the main part of this post.

1. Consider this policy proposal:

"I think the Bank of Canada should switch from targeting CPI inflation to targeting wage inflation. I'm not hung up on the exact rate of wage inflation the Bank should target. My guess is that something like 2.5% wage inflation would be roughly right, and would give us roughly the same 2% CPI inflation in future. But if you want to argue for a higher or lower target rate of wage inflation, I don't really care a lot. So if wages start to increase faster/slower than 2.5%, the Bank of Canada should raise/lower interest rates, reducing/increasing demand for goods and labour, which would put downward/upward pressure on wage increases."

(BTW, I'm not actually proposing that, though it's not a bad policy, and is worth considering. And the merits or demerits of that proposal is not the point of this post.)

2. Reactions.

2a Macroeconomists. Any New Keynesian (for example) macroeconomist would react to the above policy proposal like this:

"Ho hum. Nothing new here. Nick hasn't even given us any reasons why targeting wage inflation would be better than targeting CPI inflation. I could build a model where one would be better in some cases, and the other would be better in other cases. It all depends on: whether wages are stickier than prices; on the source of the shocks; the exact specification of the model and its parameter values; and stuff like that. It might matter in the short run, but won't matter much if at all in the long run (unless better performance in the face of short run shocks leads to a higher growth rate).

Is Nick's policy "anti-labour"?? Don't be silly. Of course not. You would get exactly the same average levels of real wages and employment with either target, unless there are some sort of weird non-linearities in the model, or if better short run performance in the face of short run shocks leads to a higher growth rate. It's got nothing to do with being pro- or anti-labour."

2b. Non-economists. I'm guessing here:

"Nick's policy is anti-labour. He doesn't want workers' wages to increase. If he sees workers getting a better deal, he wants the Bank of Canada to tighten monetary policy to increase unemployment to weaken their bargaining power to force wages down again. Nick's policy isn't just anti-labour, it's deeply immoral in using unemployment to fight against workers' interests."

Roughly right?

2c. This one's trickier. Suppose you were a labour union leader who also believed in (something like) New Keynesian macroeconomics. In other words, you had the macroeconomics of (say) Paul Krugman, but your job was to run a labour union.

Even if you thought, as a good New Keynesian macroeconomist, that the policy might either be better or worse than inflation targeting, depending on the precise model, you would be very wary of the policy.

First, a lot of your members would be against it, for the reasons given in 2b above.

Second, if the wage targeting policy were implemented, and even if you knew, as a good New Keynesian macroeconomist, that it would make little or no difference to real wages and employment, which is what you care about, and that it made no difference to whether unions are good or bad, it might make a massive difference to how your job was perceived.

Suppose you managed to get an above-target 3.5% wage increase for your members. Everyone might then say: "Oh, that's great for your group of workers, but it simply means that some other group of workers are going to have to accept a 1.5% wage increase, to keep the average at 2.5%, and the Bank of Canada is going to have to make sure there's enough unemployment to force some other group of workers to only get 1.5%!".

And you would be left desperately trying to argue: "No, it doesn't mean that, because our wage increase could mean that average real wages would go up, even though nominal wages can't, because prices could come down as a result of our wages going up.....because,....er,..., well , it's all to do with the long-run neutrality of money, and the difference between real and nominal wages, and.....err....let me try to explain to you how this works.....brothers and sisters."

Would you want your job to be perceived like that? Would you like your job to be to have to try to explain that an increase in your wages might mean a fall in prices and an increase in average real wages even though average nominal wages were fixed by the Bank of Canada? Even though your argument for the benefits of union power would be equally valid (or equally invalid) whether the Bank were targeting CPI or nominal wage inflation?

Of course you wouldn't. I wouldn't wish that job on my worst enemy. Instead, you would say "Oh, to hell with trying to explain all that in New Keynesian macro, let's just blame the Bank of Canada for not letting us increase wages without creating unemployment! I can explain that to my members."

3. Coda. Back to macroeconomists: given the likely plausible reactions in 2b and especially 2c above, I wonder if your 2a is the correct answer?

* "Political economy" has two (modern) meanings. It can mean political scientists bullshitting about economics. Or it can mean economists bullshitting about politics. Economists tend to use the words in the second sense. Non-economists tend to use the words in the first sense.

The original is actually the rather clever: "when I hear of culture... I unlock (entsichere) my Browning". Browning being both a poet and a make of gun.

Comments

[Bob Murphy]

This is why you should support a gold standard. Stick it to the mine owners!

[Nick Rowe]

Bob: that was good for a laugh! There's now tea all over my keyboard.

[RN]

2a is still the correct answer. More or less. It's a bit of a macro copout, but no need to bother delving into that here. It's the inescapable occupational hazard.

But the essential underlying issue is interesting, and not just in this very limited targeting context, but how the same dynamic plays out in lots of other areas too. Like fiscal policy decisions. Or regulation.

It also kind of demonstrates why the mostly undiluted macro view of Krugman has almost always turned up the right answer as of late. And why the policy-shaded work of the Chicago folks or his Royal Idiocy Niall Ferguson has proven dismally wrong of late.

[Nick Rowe]

RN: glad to see you got the point of the post. But you lost me on your third paragraph. Sorry.

[Stephen Bank]

I'm no big city macroeconomist, so maybe I missed something important here, but would it be so hard for a labour leader to say "when you adjust for inflation, this won't affect your pay"?

Is there more to it, or is it just reasonable to assume that the average person doesn't understand inflation?

[Zac]

Surely one equilibrium is for unions to generally accept 2.5% wage increases, for the reasons you suggest, and the primary goal of union negotiations shift towards improving workplace non-wage benefits like OH&S, healthcare, flexible time etc.

I suppose though if those benefits feed through to the firm's marginal cost, then it would have the same macro-economic effect as the wage increases that they are replacing.

I cannot imagine any central bank would like to get stuck in the quagmire of attempting to quantify the benefits and costs of new OH&S or healthcare benefits...

[Nick Rowe]

Stephen: but the union leader would have to argue something harder than that.

In both cases (nominal wage target and CPI target) he wants to argue that average real wages will increase if his members get a 3.5% wage increase

1. With the Bank of Canada holding the time path of average nominal wages constant, he would have to argue that his members' above-target wage increase would cause the price level to fall.

2. If instead the Bank of Canada were holding the time path of average prices constant, he would instead have to argue that his members' above-target nominal wage increase would not decrease other workers' nominal wages.

Both arguments 1 and 2 are economically equivalent. But rhetorically, it would be easy to convince people of 2, but very hard to convince people of 1. I would hate to have to try to explain 1 to people using words, and no math or diagrams. It would be really easy to give an answer to 2 that sounded totally convincing, even if the reasoning was total BS.

"Hey, if our wages go up, and the Bank of Canada holds prices the same, that means our real wages go up, right? And if our real wages go up, that means average real wages must go up too, right?"

That argument above sounds convincing, right? But it's total rubbish.

How about this:
"Yep, if our money wages go up, that does mean that some other workers' money wages must come down. But that means the Bank of Canada will have to force prices down to makes some other workers' wages go down. So that means average real wages will go up, right?"

That argument sounds totally unconvincing. But it's much more correct than the above.

[Nick Rowe]

Zac: "Surely one equilibrium is for unions to generally accept 2.5% wage increases, for the reasons you suggest, and the primary goal of union negotiations shift towards improving workplace non-wage benefits like OH&S, healthcare, flexible time etc."

OK. Let's run with that. But, what that means is that there's a big long run non-neutrality of monetary policy, if you are right. Nominal wage targeting will lead to higher long run non-wage benefits and lower real wages than CPI targeting. Weird, huh?

[Determinant]

A New Keynesian Union Boss? I should very much like to meet such a creature. Pray tell where does this species live?

[david]

A macroeconomist who believes in long-run money neutrality of course subscribes to the notion that nominal levers cannot affect labour or capital's share of income. As a union boss you're supposed to have control over real factors though.

As for the optics of it, you could always hold a nice public ceremony with your favorite central banker pledging to decrease prices. Because that's what would have to happen, right?

[Nick Rowe]

Determinant: if one existed (and I think one once did) would he ever admit it? I think my post might explain why not.

David: neat! But I find it hard to imagine. Reminds me of Keynes' "monetary policy by the Trades Unions" bit.

[Peter]

Non-economist here. Union member, but not active in any way.

Is this an attempt to explain why Scott Sumner gave up arguing for a wage target? Or how different central bank's targets might have weird effects?

I mentioned wage targeting to someone (a non-economist I suspect) on a forum once. He didn't believe that a central bank could influence the wage level.

I suspect the union leader might take the easy route and argue against the central bank's wage target. It's up to the good guys to explain to the public why it's a good target. I doubt it will be easy. Likewise for NGDP level targeting. Why shouldn't we keep inflation and unemployment low any more?

[Kosta]

Nice post Nick, I think it hits home quite nicely after Inflation Fallacy post. As a pro-labour non-economist, I think it is deeply immoral to use unemployment to fight against the worker's interest :). But it is splendid how you've highlighted that CPI targetting does the same thing.

From the perspective of 2c), would the policy choice not be more palatable if it does not so explicitly target one specific sector of the populace (i.e., workers). A clever pro-labour economist would realize that the policy choice nearly guarantees 2.5% increases in wages, which is a good thing. However, how does he or she sell it to labour, when they realize that their paychecks are being targetted during good times? Just consider the potential problems if when during the next expansion the BoC acts to restrain wage growth, while corporations and business owners are making record profits.

Whether or not the policy is unfair, it will be perceived as unfair, with the workers losing out, whether true or not.

[Alex]

Suppose you managed to get an above-target 3.5% wage increase for your members. Everyone might then say: "Oh, that's great for your group of workers, but it simply means that some other group of workers are going to have to accept a 1.5% wage increase, to keep the average at 2.5%, and the Bank of Canada is going to have to make sure there's enough unemployment to force some other group of workers to only get 1.5%!".

To be *really* cynical, the other group doesn't get to vote in my re-election, so the point is moot (obviously this is more appropriate if you have craft unions rather than OBU).

[Steve Waldman]

Nick — This is a fun post, and reasonable as far as it goes.

But to the degree that it is inspired by real-world critiques that central banks are anti-labor, it is off the mark. Central banks frequently treat stable unit labor costs as a key marker of price stability, and in practice seem to cap unit labor costs, or at least threaten to contract in the face of unit labor cost growth.

A good New Keynesian macroeconomist, of course, would point out that unit labor costs, which reflect the split of income between labor and capital providers, represent a real rather than nominal variable, and it would be foolish for central bankers to try to target such a thing. And yet, throughout the triumphalist Great Moderation, central bankers ostentatiously tut-tutted expansions in unit labor costs with threats of aggressive contraction.

I didn't much hear good New Keynesian macroeconomists objecting.

The reason your labor leader's New-Keynesian-correct argument is hard as a matter of political economy is because real world central banks have rendered it implausible, and that has conditioned convention wisdom. If we had experienced periods where nominal wage growth was stable but real wage growth accelerated, it would be possible to argue that a good deal for our workers is a good deal for labor generally, because the real burden of our good deal will be borne by capital providers. But if central banks threaten to drive the economy into recession if a floor on capital's share is busted, that argument holds no water.

(I'm assuming real GDP growth is inherently constrained. Even with central bank suppression of unit labor costs, a labor leader could argue that a good deal for his workers is a good deal for labor generally, because the pay raise will enhance overall real growth. Capital providers make that argument constantly and with astonishing success, politically. But it sounds risible when applied to labor.)

[Nick Rowe]

Peter: "Is this an attempt to explain why Scott Sumner gave up arguing for a wage target? Or how different central bank's targets might have weird effects?"

I don't know why Scott gave up, but this is one reason why any central bank would think twice before targeting wages. (And why the Bank of Canada never talks about the natural rate of unemployment, but instead talks about "potential output").

But that point is sort of obvious. It's more about how different central bank targets might have weird effects.

Kosta: "But it is splendid how you've highlighted that CPI targetting does the same thing."

All monetary policies would do the same thing. Therefore none can be immoral.

Alex: "To be *really* cynical, the other group doesn't get to vote in my re-election, so the point is moot (obviously this is more appropriate if you have craft unions rather than OBU)."

Most economists would react: that's not being really cynical; that's obviously how it is.

[Andrew Bossie]

I'm pretty sure the divide here is a theory and practice divide. Nominal wage increases are the result of relative bargaining power between "labor" and "management" over the returns to productivity gains. Asking to target nominal wages is asking to further neuter labors ability to bargain.

The reason you get effective price level targeting from wage targeting is becuase in New Keynsian/DSGE models wages are effectively the only "variable" that determines price labor unions bosses know that's not true. Anyway, I agree that we should not be using DSGE models to bullshit about politics.

[John]

nick,

it is probably one of your easiest post for non-macro economist. You often use ad curves and stuff like that...

student in first year intro class learn the difference between nominal and real wage.

I think 2b is exagerated. I think many people can be educated about the difference between real and nominal wages. 2a is correct.

[Jacques René Giguère]

As an economist ( eclectic Keynesian, too old to be new) and labor boss ( yes Determinant, they exist), I agree with Nick... There is even an college economics professor, a long= term friend of mine, on the Board of the Confédération des Syndicats Nationaux CSN). He gave up long ago on explainig economics to his members.
The way I gave up explaining why it would good for workers to raise Hydro rates and use the proceeds to hire nurses instead of paying C$ 100 K to high school dropouts working in a subsidized aluminum plant ( that's where I lose them....)
Economics and political science were long the same thing . In Canada they officially separated in 1958 IIRC.
If you think it is hard to explain sound economic policy, try vaccinating against cervical cancer in Texas.

[paine]

my point as an attack trained macronaut
the diference between targets for core inflation and targets for some wage rate index
are matters of fine tuning

the core target is a fig leaf for what in esence is a control of the rate of change of wage rate
overt control would be completely non PC

'nough said

btw
target wage rate not wage rate change
use policy to follow a path of nominal wage rates
get knocked off return to path asap

[paine]

"Suppose you managed to get an above-target 3.5% wage increase for your members. Everyone might then say: "Oh, that's great for your group of workers, but it simply means that some other group of workers are going to have to accept a 1.5% wage increase, to keep the average at 2.5%, and the Bank of Canada is going to have to make sure there's enough unemployment to force some other group of workers to only get 1.5%!"."

excellent point

and precisely why price targets are prefered by us pro union nitwits

now if you had a nominal value added per hour target ....then the "bossdes" might take the loses " eh ???

[question]

are you really an economist with only a BA?

I think to really understand througly issues, you need at least an MA

[paine]

the changes in unit output per hour ie real output per hour change
is a second dimension to wage rate change
perhaps the union claims we had higher unit output so our impaact on unit cost is zero or just 1% and under the target etc

price indexes correct for changes in out put
are you correcting for changes in output per hour ????

i'm sure others have made all these points in comments above
just wanted to second these points in a sloppy way

this post is exactly what i like to see academic macrotoons doing nick

[paine]

using the term "wage inflation" may compress to much content

[paine]

"are you really an economist with only a BA?

I think to really understand througly issues, you need at least an MA"

that is dangerously off course
i think the ranks of macronaut cadets trained in graduate schools after say 1982 got brain washed
of course 101 texts have aught up with the brain wash more or less

samuelson first edition would lead to better macro then most current graduate courses

i recall my own course under phelps at columbia

occured during the expectations revolution

and already this
plus the so called wage push inflation of the 70's
created a generation of half wits

shuttering in the shadow of inflation

[paine]

unless your micro foundations have ample room for both heterogenious firms and firm pricing power

you have modeled a wonderland again

[paine]

"that point is sort of obvious. It's more about how different central bank targets might have weird effects"
weird as in primary signifigant different effects

if as you have you abstract for real target numbers you remove the debate

i suspect you share the pair of knocking knees the words wage inflation trigger in those "effectively " conditioned in grad school post 1979

lets look for weird secondary effetcs of changes in target type
not changes in target numbers

ya the monk and his conjury of an infinitude of extensionless angels

making a nice practical field like macronautics
into a semblance of the philosophy of mind

lets get to it brothers and sisters

the point is selecting the right target level
whether its inflations of prices or wages
and given shocks and internal eruptions that number changes from contect to context from major event to major event

we now have a rising debt to gdp ratio
i suggest that pushes higher targets onto the agenda

nick seems to think he wants a for all time and contexts rate on the safe side of zero

imagine suggesting deflation even in one sector given current debt loads

look at the giips
they need germany to raise its wage rates yes acclerate wage inflation

in a community of brains orbiting the rowe sun

this is monstrous it violates optimal rate change norms

btw
this is nicely brief aand sharp
"...And why the Bank of Canada never talks about the natural rate of unemployment, but instead talks about
"potential output"..."

yes they are one and the same
much to the misdirecting of the populace

if we look to the arsenal of democracy years ghere in the states 1940-1944
we see the huge elastcity of actual "potential output

[Nick Rowe]

Andrew: "I'm pretty sure the divide here is a theory and practice divide. Nominal wage increases are the result of relative bargaining power between "labor" and "management" over the returns to productivity gains."

You can do a NK model with either monopoly power or monopsony power in the labour market. My guess is that a relative bargaining power model would be a convex combination of those two. Not sure if it would add much to the monetary policy aspects.

John: "it is probably one of your easiest post for non-macro economist."

Maybe you're right. I was just a bit burned out from arguing basics of monetary policy, and wanted a break. And the "political economy" bit in the title is a bit of a red flag to some, so I wanted to head them off early. It's *my* turn to talk about what *I* want to talk about, for a change.

"I think 2b is exagerated. I think many people can be educated about the difference between real and nominal wages."

Yes, but when you talk about the *determination* of real and nominal wages, it gets a bit harder. I hear something like 2b far too often. Maybe I'm getting a biased sample.

Jacques: yep. That resonates.

paine: "now if you had a nominal value added per hour target ....then the "bossdes" might take the loses " eh ???"

That's what it would look like. But I still prefer Bob Murphy's idea: target the price of gold, so you really stick it to the gold mine owners!

[Shangwen]

I started reading this, and at the exact moment that I began to think I understood it, I plunged my hand into freezing water.

[RN]

Nick:

I apologize for not being clearer in the 3rd paragraph. My writing skills aren't always what they should be.

All I was trying to say is that there are times (such as now) when a good hard look at the economics in an apolitical and brutally honest analytical way is much more important than usual. There are 2 big reasons for this:

1) a) the issues, both economic and financial, are unprecedentedly complex (ever-increasing number/kinds/access to financial instruments and systemic interconnectedness), and b) there's less historical precedent (the uncharted waters problem) to draw from in trying to sort out what's going on now and what best policy might be going forward.

2) we're in the very sad situation that in the balance of factors that are going to guide how the global economy recovers, markets have as little influence as they've had in a long time, and policy makers have more influence than they've had in ages. Your financial future depends to a downright silly extent on what a single person like Angela Merkel or Ben Bernanke (or Eric Cantor, for that matter) happens to say or do. This is very dangerous, and the upshot is that ideas go a long way in this environment. And if the ideas are bad, the ramifications can be extremely serious. Markets run amok generate huge pressures and distortions as we've seen. But markets held neutered - as now - can't operate as a counterweight to bad decisions. A consummate example of this was the debt ceiling fight in the US, where sheer idiocy almost led to default, and higher borrowing costs that were completely uneconomically generated.

So when ideas have such power, and markets so little, the quality of the ideas becomes more important than ever. Hence my respect for people like Krugman - politics/ideology aside - who take the analysis and reasoning so deadly seriously. So many have succumbed to arguing for what "feels right" (got debt? reduce debt! Period, paragraph.). Well, no: this is no time for “gut” reactions. The way to proceed, especially in such times, is with all the objectivity we can muster.

In many ways, with regard to the global financial system, we humans have built a robot we don’t understand. If it’s eating us and we want it to stop, it behooves us to examine how it actually works and not pretend it works some other way because we wish it did.

[Scott Sumner]

I think Steve Waldman's comment is wrong (the central bank has no control over the trend rate of real wage growth) but it helps explain why I abandoned the idea. It's a hard sell politically, even in a big country like the US, where I believe no labor leader would be embarrassed to ask for more money, as they are all such a small share of the labor force. The other problem is that hourly wages may be hard to measure. What's a CEO's hourly wage?

Steve's comment does raise an interesting question, however. Why did central banks care about wages? Here are two possibilities:

1. They instinctively knew wage targeting was superior.
2. They used it as an indicator of inflation expectations, which is what they really cared about.

[rp1]

Another non economist view: WOW, I'm going to borrow as much money as possible right now and continuously in the future, as interest rates skyrocket as a result of this insane policy. We supposedly have free markets, yet the BoC will knock down the real burden of all debts by 2.5% per year. Who is going to invest and manage risk in that environment? Simply borrow and hoard. Get yours while you can, because if you thought lending 750k to 25 year old couples to buy houses was crazy, you ain't seen nothing yet.

[rp1]

BTW, this is not a hypothetical situation for me. I have money in the bank. I am trying to be responsible and provide for a young family, and I am getting burned. Nominal wage targeting would flip a switch for me.

[Nick Rowe]

Steve: sorry your comment got lost in the spam filter again. I fished it out.

I'm not sure why you say that unit labour costs are a real variable. I think they are a nominal variable. Unit labour cost = nominal wage divided by output per worker. So unit labour costs have the units $ per apple.

There's something doubly strange about the idea that targeting nominal wages would be anti labour (or that targeting nominal gold prices would be anti gold mine owner [though Bob Murphy was of course joking])

1. The obvious distinction between real and nominal wages (real and nominal gold prices).

2. Ignoring the real/nominal distinction, you could equally well argue that the Bank would be keeping wages (gold prices) up, as keeping them down.

Shangwen ??

RN: Thank. I follow you now.

Scott: Agreed on the real wage trend being (roughly) independent of monetary policy. Recognise though, that a better monetary policy, that improved short run stabilisation, might improve long run real growth, which would probably be good for real wages and real income generally. Long run investment would probably be higher if monetary policy were better. And in an AK growth model that would mean permanently higher growth. (We short run macroeconomists shouldn't let the growth theorists get away with saying short run macro doesn't really matter!)

I think the strongest argument for targeting nominal wages would be if you argued that you should target the stickiest price. But yes, I'm not sure how well we measure nominal wages. (Just look at Stephen's latest post, where two different measures of real wages (but with the same CPI deflator) behave very differently in 2001.)

Plus the politics.

[Adam P]

Nick,

While it's true that unit labour cost is a nominal variable (don't know why Steve thinks otherise) Steve still has a point here.

If you want to target 2% nominal wage growth as basically similar to 2% inflation then you need to adjust for productivity growth.

2% growth in nominal wages with 2% goods price inflation and postive productivity growth means falling real wages.

2% growth in unit labour cost with 2% goods price inflation is stable real wages. Isn't that the preferred outcome?

I made this point on Stephen's real wage post, during the recession (at least in the US) unit labour costs fell while core cpi stayed just above zero. That is a fall in real wages.

[Adam P]

Well, the 2% growth in unit labour cost with 2% goods price inflation case is stable real wages from the point of view of the firm, it is stable real marginal costs to the firm, so that is the outcome you want for stabilizing output.

Presumably the labour supply decision depends on real wage per hour, so from the household point of view their real wage isn't stablilized but it only falls when their productivity falls and you can't cheat that so you don't want to resist that fall.

[Nick Rowe]

Adam: suppose the only real (supply-side) shock was a shock to labour productivity.

I *think* (I'm not sure) that the model you have in mind is one where prices are sticky but nominal wages are flexible. In that case, I think targeting nominal wages would be a bad policy (unless you adjusted the target for labour productivity shocks, in which case it would be the same as targeting prices). So (I think) I'm agreeing with you in that case.

My hunch though is that nominal wages and nominal prices are roughly equally sticky. So (if you weren't allowed to adjust the target for productivity shocks) I'm not sure which is better.

[Nick Rowe]

Adam: Hang on. You lost me here: "2% growth in nominal wages with 2% goods price inflation and postive productivity growth means falling real wages."

Aha, now I get it (I think). You are talking about the difference between output price inflation and the rate of inflation of the consumer goods the workers buy. So there are 3 (not 2) different inflation rates: wages; output prices; consumer prices. OK. I'm not sure in that case.

[Shangwen]

Nick: sorry for the bizarre comment. I was trying to crack a joke about me as a non-economist trying to rid myself of the delusion that I could understand (as in, really get) the meaning of the post.

[anon]

The really interesting thing about this policy is how it could interact with downward wage stickiness. Perhaps it makes it easier to ask for nominal wage cuts during recessions, because the central bank will make sure that some other workers get a nominal raise; and conversely, it makes it harder to ask for high nominal wage raises, because then some other workers might see their nominal wage cut. Overall, it seems that unions will partly internalize the economy-wide effects of nominal stickiness; so efficiency should increase. But I'm not really sure, this is a tricky issue.

[Scott Sumner]

Nick, Agree about the secord order effects on real grwoth.

I've always thought of nominal wage targets as a way of keeping the aggregate nominal wage close to its Walrasian equilibrium value. I don't know it that's a valid argument, or the extent to which it overlaps with the "stickiest price" argument. I assumed overlapping long term nominal wage contracts, where the number of independent negotiations was alrge enough that this period's nominal wage gains were an excellent estimate of the optimal wage gain of those workers still under contract.

[Steve Waldman]

Nick, Adam — Suppose there is an increase in unit labor costs. What might that reflect?

1) It might reflect a change in the price level — the price of apples has risen in our apple economy and with it the price of labor. The change in unit labor costs is a nominal phenomenon.

2) It might reflect an increase in the share of apples paid to laborers as opposed to other input providers. This is a real phenomenon — perhaps due to changing marginal productivities, perhaps due to changes in bargaining power, perhaps due to sunspots, labor is receiving a greater share of output than previously while the price of apples has not risen.

Unit labor costs are a very odd thing for central banks to focus on if nominal changes is what they are after. Why not just pay attention to the price of apples? Why not put a cap on unit capital cost, which would rise as surely with a change in the broad price level as unit labor costs?

There is an answer — labor is deemed to be an unusually sticky price, and New-Keynsianish intuitions suggest stabilizing the inflation rate of sticky-priced goods.

But unit labor costs are not strictly a nominal variable, and a side effect of threatening contraction whenever unit labor costs expand is to diminish the bargaining power of labor with respect to capital.

Perhaps it's easier to do this with a bit of math: It's easy to show that

labor_share = (unit_labor_costs / price_level)

If labor share is to expand, then either unit labor costs must increase or the price level must decrease. But, if central banks credibly resist price level deflation, which they do, and if they credibly threaten to contract even to the point of recession should unit labor costs expand, which they also do, the effect is to tell labor that it is hopeless to bargain for higher wages. Which is why many people sympathetic to labor reasonably detest the actual practice of central banks.

Note that this is not an argument against your thought experiment. There would be nothing wrong with targeting wage growth and letting other prices fluctuate in both directions. Increases in labor share would then show up either as an increase in unit labor costs, a decrease in the general price level, or both. I have no argument with your post, it's all good.

But the inference that hostility to central banks in the real world is a result of mere fallacy by noneconomists is a step to far. The actual practice of central banks that resist both deflation and unit labor cost growth is hostile to labor.

[K]

Steve: "The actual practice of central banks that resist both deflation and unit labor cost growth is hostile to labor."

Well it certainly would be. But can they? I would think that both of those things would tend to respond in the same direction to most central bank actions. What, for example, could they do to move them in opposite directions?

[Nick Rowe]

anon: "Overall, it seems that unions will partly internalize the economy-wide effects of nominal stickiness; so efficiency should increase. But I'm not really sure, this is a tricky issue."

That's sort of my feeling too, though I would replace your "will" with a "may". Especially the bit about it being a tricky issue. It's just not obvious to me how it would play out. That was the main point of the post. It cheers me to see someone pick up on it.

[anon]

If labor share is to expand, then either unit labor costs must increase or the price level must decrease.

Um, no. What if both occur? Then the central bank is stuck targeting a trade-off of nominal wages and the price level. Moreover, keep in mind that every action by the monetary authority affects both of these variables. So the trade-off is always binding.

Perhaps the central bank wants to target prices when labor share is low, and unit costs when it is high. (Because the amount of labor share changes the effects of price vs. wage stickiness.) Then they will engage in this policy. Besides, it is only "hostile to labor" during economic expansions. During recessions, it suddenly becomes "labor-friendly" and "hostile to capital".

[Nick Rowe]

Steve: I might sort of see what you are getting at, but K's answer would be the orthodox New Keynesian response. Central banks can't affect labour's share in the long run, precisely because it is a real variable. They can only affect the variance of labour's share.

(And sorry about the spam filter again.)

[Steve Waldman]

Nick — You should apologize to your readers for overriding the exquisite good taste of your robot editor, not to me. Obviously, the problem is my logorrhea, and not anything at your end.

(A long post will follow a few minutes after this one. If you don't see it, you may prefer to refrain from checking your spam filter.)

[Steve Waldman]

Nick, K, anon — Well, I'll confess that I'm way off the New Keynesian reservation. Might as well go all the way to Old Marxian. Let's suppose that the tools of the central bank are captured by providers of capital, who wish to cap labor's share of output. How could they use the central bank to further this aim? As you say, interventions that put upward the price level typically put upward pressure on unit labor costs, and interventions that restrain unit labor costs put downward pressure on the price level. In a New Keynesian world, with long-term neutral money and no questions of power, a central bank would be helpless to control this real variable.

Yet, we agree (no?) that in the short-term, in the real world, central banks can provoke recessions. And we also know (here's a US graph http://research.stlouisfed.org/fred2/graph/?g=3BD — sorry Nick to be less familiar with Canadian data sources) that wage share typically falls in recessions. It is plausible (though admittedly arguable) that capital providers, as a group, are better able to tolerate the pain of recessions than those who subsist by sell labor. If so, the ability to provoke recessions via the central bank gives capital providers bargaining power.

To whatever degree wages are affected by activities like organizing and collective bargaining, central bank policy could serve as a powerful counterweight. Why organize to push for higher wages when, if you succeed, the central bank will engineer a recession to set you back again? The central bank serves as a different sort of Chuck Norris in this story. You don't even try. You focus on family leave and working conditions and stuff like that.

In the US, labor's share has been in chronic decline. I'm sure much of that is due to real factors like globalization and technology. But the decline of unions is a part of that picture, and that decline has coincided with the rise of a central bank that has persistently and credibly communicated its willingness to accept recession rather than tolerate unit labor cost expansion. After George H. W. Bush blamed his loss in 1992 in part on Fed policy, Democratic policymakers became reluctant to pursue labor friendly policies that might provoke a central bank contraction. (See the acres of ink spilled on Bill Clinton's policy shifts and tacit bargains with Alan Greenspan.)

Scott Sumner sometimes wonders why the left isn't more supportive of market monetarism. Especially now, when the burden of indebtedness is pressing among the nonaffluent, the benefits to ordinary workers of a rising price level probably exceed any threat to labor share or risk that wages will fail to keep pace. An NGDP-targeting central bank would deliver either debt relief or real growth or both. If we were starting from a clean slate, I think Scott's expectations of enthusiasm from the left might have been realized. But we are not starting from clean slate, and I don't think people's suspicions of the US central bank are entirely misplaced.

[Nick Rowe]

Steve: start in full LR equilibrium. Then the central bank says to person Y: "Do X, or I will create a SR recession". Where Y and X could be anyone or anything, as long as the cost to Y of doing X is less than the cost to Y of a SR recession.

Does your argument generalise like that?

[Nick Rowe]

BTW, I *think* (I'm not sure) that labour's share of GDP rises in recessions in Canada. Stephen's graphs in his recent post show that real wages are roughly acyclical, and Okun's Law still works here, so employment falls less than GDP percentage-wise.

[Steve Waldman]

Nick — Ceteris paribus, if the cost of conflict is greater for one party than for another, the party with the lower cost of conflict is more likely to get its way. But ceteris is not always paribus. Maybe the party that bears the higher cost from one round of conflict also has more to gain or less to lose long-term than the other party, and so endures. Maybe the conflict is sufficiently costly that neither party engages, so the relative cost of conflict is irrelevant. Maybe one party is ideological or irrational, willing to make sacrifices what we would impute as large costs because their cause is divine or they are spiteful or simply nuts.

A central bank that tries to employ a "grim trigger" strategy by imposing recessions on restive labor is not preordained to win. I'm certainly not claiming central bank omnipotence in this or any other matter. But, all else equal, the ability to credibly threaten a recession to parties who stand to lose more than you do is a powerful bargaining chip.

Again, the story of declining labor share in the US is likely more due to globalization and technology than any central bank strategy. But expectations about central bank reactions do affect and condition the behavior, of ordinary people and of policymakers. Magnitudes are uncertain. Perhaps there was no material influence. But the direction of the effect at the margin was pretty visible, and engendered a fair amount of hostility.

[Alex]

Steve Randy Waldman has put the essence of my criticism of NGDP targeting rather well and I think I'll leave it to him.

I will however disagree with this, or rather, the conclusions that follow from it:

Central banks can't affect labour's share in the long run, precisely because it is a real variable. They can only affect the variance of labour's share.

This is far from a trivial issue. Among other things, I would expect that a high-variance economy would exhibit a very high savings rate and depressed aggregate demand as people self-insure against the inherent uncertainty. I wonder if that is actually rather what is going on in places like China?

[Nick Rowe]

Alex: I was wondering about that myself, if you and Steve might be on about the same thing.

"This [variance] is far from a trivial issue."

Indeed. This to me, and to most macroeconomists, is a very big issue indeed. It's why we argue about inflation targeting vs NGDP targeting etc. Which one best stabilises the economy? Which one minimises the variance? (Though we have to be careful how precisely we define "variance", because some types of variance may be a good thing.)

Steve: I think the model you have in mind is where there's One Big Union in a game against the Central Bank. 2 player game. And we don't know whether they will play Nash, or whether the OBU or the CB will be the Stackelberg leader. And a switch from (say) inflation targeting to nominal wage targeting (or NGDP targeting, or whatever) is like a change in the strategy space and can affect the equilibrium.

People have modeled a 2 person game between the CB and the fiscal authority. (Did it myself once, but I can't immediately recall the model.)

There's also that literature on "Corporatism", (Dennis Snower?) where you sometimes get better results with OBU than with lots of little unions. And examples (like Ireland or the UK) where you try to get an agreement between the OBU and the government in which the OBU keeps wage inflation low while the government increases AD. Those models never really made it across the Atlantic (though I did one once) because unions were never that centralised here. They died out in the 1990's AFAIK.

[Nick Rowe]

Alex: "I wonder if that is actually rather what is going on in places like China?"

I don't *think* so. More likely that people in China are saving to insure against individual specific shocks (with no social insurance). Or against political risk, rather than AD shocks per se, which might be small in comparison.

[aelilea]

Steve and Alex may also be referring to the empirical evidence regarding how central banks actually implement their stated target, e.g. as in http://utip.gov.utexas.edu/papers/utip_42.pdf

[Alex]

And examples (like Ireland or the UK) where you try to get an agreement between the OBU and the government in which the OBU keeps wage inflation low while the government increases AD

Germany in the GFC. Lohnzuruckhaltung in full effect, jobs protected via short-time working with partial compensation, both agreed through the tripartite system, and a substantial fiscal stimulus (the biggest increase in public debt as a % of GDP for discretionary stimulus, according to the IMF). Seemed to work pretty well, although hard to distinguish good structure from good policy.

[Nick Rowe]

2 player game, between OBU, which sets W, and CB, which sets M. Both have preferences defined over W and M.

1. Nash equilibrium with simultaneous moves: just like Kydland and Prescott, Barro and Gordon. High inflation natural rate equilibrium.

2. OBU moves first, and CB moves second. Corporatist solution, because OBU knows that the LRPC is vertical, so it keeps W low. Unemployment at natural rate, low inflation. "Monetary policy by the trades Unions".

3. Suppose the CB can make binding conditional commitments. CB announces a threat for M, conditional on W. The CB can reward or punish OBU behaviour. The CB can get the unemployment rate below the natural rate, in equilibrium?

[Nick Rowe]

aelilia: I briefly skimmed that Jamie Galbraith article. Here's my take.

Just assume that his VAR results are correct. OK, so the Fed has a rather weird kinked Taylor Rule. It tightens in response to low unemployment, and loosens in response to low inflation, rather than responding symmetrically to both.

If you put that instrument rule into a standard NK model, it would (almost certainly) not be optimal. It would only be optimal (I guess) in some equally weird kinked NK model. (But maybe the real world is kinked, or at least non-linear, so a non-linear instrument rule would be best).

It would affect the *variance* of unemployment, but not affect the *average* rate of unemployment (if you put that kinked Taylor Rule into a standard linear NK model).

[Mandos]

A central bank that tries to employ a "grim trigger" strategy by imposing recessions on restive labor is not preordained to win. I'm certainly not claiming central bank omnipotence in this or any other matter. But, all else equal, the ability to credibly threaten a recession to parties who stand to lose more than you do is a powerful bargaining chip.

That's why central bank presidents, boards, etc, need to be popularly elected.

[Leigh Caldwell]

When I read this two weeks ago I thought there was something missing, but I couldn't quite see what it was. I was just reminded to come back and look again by @stephenfgordon and @mattyglesias on twitter.

I've realised that I didn't instinctively see the proposal as being anti-labour, or even as looking anti-labour to voters. A more sellable (or in Nick's term political-economy-compatible) proposal might be the following.

1. Target a wage increase of not 2.5% but 4%.
2. Based on expected productivity increase of 1.5-2% per year, this should be long-term equivalent to a CPI increase of 2-2.5%. Make sure CPI figures are still published so that people can see the difference between the two.
3. Sell it to voters as a real-terms annual increase of 1.5-2% (plus whatever you get from being promoted or gaining more experience or seniority in the workplace - which every voter, being overconfident, will expect to happen disproportionately to them personally)

As Nick hinted, it might seem to a macroeconomist like this is effectively equivalent to his proposal, but I think to a voter it's not. The 4% increase is better compared to pre-existing anchors than 2.5%. And a focus on productivity and showing the difference between CPI and wages would help to make the idea more popular.

Am I wrong on the productivity figures? In the long run will it matter what the actual number is, once this expectation gets baked in? I'm not sure, but I think this proposal would be more politically achievable than Nick's, just because of that change in number.