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Nice post Nick. It was Friedman who said it. Although I'm sure you knew that.

Bernanke talked quite a bit about the "price-level gap" in Japan in the 1990s. I haven't heard him or anyone at the Fed mention it lately though. Curious.

I'm not mistaken, you wrote a post back in September of 2010 responding to Sumner in which you argued that inflation-targeting was superior to price level targeting becasue inflation is stickier than the price level. Have you changed your view? Here's what you wrote last fall:

"The primary reason why monetary policy matters is sticky prices. And it's not really the price level that is sticky; it's the inflation rate."

Thanks Gregor. Post updated. My memory is bad, I had forgotten it was Friedman.

"Bernanke talked quite a bit about the "price-level gap" in Japan in the 1990s. I haven't heard him or anyone at the Fed mention it lately though. Curious."

I haven't heard it mentioned either.

I did use to think it was inflation, not the price level, that was sticky. Now I'm just confused. I blame the data. The facts seem to keep changing. They won't make up their minds.


"I did use to think it was inflation, not the price level, that was sticky. Now I'm just confused. I blame the data. The facts seem to keep changing."

Well, if you look at the US data, wages (average hourly earnings) are behaving exactly as one would expect given the massive excess supply in the labour market. Wage growth is continuing to slow and is now down in the 1.5% y/y range. Over the last 24 months, wage growth has been below 2% - the weakest stretch since the beginning of the series. If the Fed had a 2% inflation target, wage growth would need to stay in the 3.7%-4.0% range over the medium term.

If I'm not mistaken, Mankiw argued that wage growth was actually the "stickiest price" and should be considered as the policy target variable.

Imagine how different Fed policy would have had to have been 18 month ago (the Spring of 2010, when wage growth was below 2.5%) if the Fed had to undertake action such that it expected to achieve 4% average hourly earnings growth by April of 2012.

The world would look very different, I think.

Hmm. Stephen's graphs do show real wages rising ( a little bit faster than normal) at the beginning of the recession, then falling a little in the recovery.


Maybe it's just that wages are slower to adjust than prices? But I don't think you get the same pattern in all recessions.

I'm still confused.

Isn't the problem that the path cannot adjust? I think the relative variable is gap between the present and expectations of the future and the prior expectations of those periods.

So it's not about: why haven't we started to expect the right future so much as why haven't we started to expect the future we used to expect.

A metaquestion would be does the media set our expectations or do they reflect our expectation. As FDR put it: we have nothing to fear but fear itself.

Jon: you lost me a little there.

I'm asserting that the relevant nominal variable isn't a variable it's a curve. There is the timepath curve we expected and the time path curve we are now experiencing an now expect. It's the difference between those curves that matters.

When the shape of the curves is simple and deviations small, we can discuss differences in the inflation rate. That's a good single number that approximates the difference between what was expected then and what is expected now. You might also attempt to approximate by comparing a single point in time. Thats the price level difference.

Both ways of denoting a single variable in \reals are approximations. The correct vertical axis is R^n if we assume discrete periods n is some time horizon.

Isn't the increase in real wages supposed to be a big part of what causes a rise in unemployment in a demand-driven disinflation/deflation? I.e. real wages lag behind the fall in prices?

For example, the US unskilled wage rose by 2% in real terms in 1930, measured by the GDP deflator. The stickiness was relative though: the unskilled wage fell in nominal terms by about 2%, while the GDP deflator fell by about 4%.

One other factor might be that, since big crashes tend to come at the end of prolonged expansions, unemployment is probably around or above the NAURU and so the bargaining position of labour is better.

Jon: I think I follow you now. But underlying your curves must be a different story from the simple Calvo story. There must be some long-ago past expectations that still matter today.

W Peden: If nominal wages kept on rising at trend, despite the recession, while prices responded quickly, then we would expect to see real wages rise in a recession. But, IIRC, that's always been an empirical problem with Keynes' theory, because real wages don't seem to be countercyclical. But it may be that some prices and wages are sticky, and other prices and wages are flexible, so we see relative wages and relative prices distorted during a recession, even though average real wages don't move much.


If nominal GDP stays on a stable growth path, then persistent supply shocks will cause the price level to move to a higher growth path and real output to fall to a slower growth path. Moving to those new growth paths combines higher inflation and lower real output growth.

Now, consider a demand side recession. Nominal GDP grows more slowly. Inflation and output growth low. Then nominal GDP grows more quickly, moving us back to the trend growth path. Inflation and real output growth spead back up.

Growth rates work great to explain everything.

Now, suppose we shift to a 14% lower growth path of nominal GDP. Inflation must remain lower for a long, long time before real expenditure rises back to trend. The price is initially 14% too high. In the U.S., anyway, it is 2% lower than trend. So there is a long way to go.

If we assume that as that happens, with inflation being 1% or something, the monetary authority will respond by having the growth rate of nominal GDP rise faster, then it is moving back up to through higher growth paths.


Mankiw's textbook has the price level, as do most. The recent Cowen/Tabbarok macro has inflation on the vertical. Therefore, instead of AD and SRAS moving further and further to the right as time goes on, they instead sort of loop around the LRAS for each year. They treat AD as being MGDP, and fiscal policy as affecting the velocity of money, neither of which Mankiw does say.

Stupid question:

When you talk about a 2 dimensional curve shifting, as opposed to movement along the curve, I interpret that as a 3-D phenomenon. (At least 3 dimensions. :)) If that is the case, why should we even think that there is another curve? Aren't we talking about a surface?

Nick Rowe,

"But it may be that some prices and wages are sticky, and other prices and wages are flexible"

I would have thought that this was uncontroversial. A highly skilled public sector worker's wage is going to be very sticky. A waiter's wages in an area with very seasonal patterns of employment will be very flexible.

For certain skilled workers in the age of inflation (say post WWII) the early period of recessions may be "catch-up" periods, especially if their wages have been suppressed by incomes policies. 2008 wasn't just the beginning of the recession; it was also roughly the peak of inflation in the decade in Britain and the US (and Canada?).

Bill: But I think the facts contradict your example. Forget the trend. Assume a stationary equilibrium. A one-shot leftward shift in AD curve (NGDP) would cause a jump down in RGDP, then slowly rising RGDP as P is slowly falling. But that is not what I see happening.

Joe: one of these days i must take a look at the Cowen/Tabbarok text.

Min: yep, it's really a 3D (or nD) surface. So, why do we do it in 2D?

1. We only have 2D paper.
2. Our brains can't handle more than 2D at once.
3. Because these 2 dimensions are special. It is P and Q that adjust to equilibrate Supply and Demand.

W Peden: Yes, it's uncontroversial that some wages and some prices are stickier than others, in practice. But how to build that into a macro model to get the right results is less obvious.

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