knzn: The Fed Should Target Unit Lbor Costs

knzn says the Fed should target unit labor costs:

Target Unit Labor Costs, by knzn: Last year (here and here, with related posts here, here, here, here, here, here, and here – or just read the August 2006 archives and my post from yesterday) I suggested that the Fed should target unit labor costs. Upon additional thought, I still think so. I won’t go through the whole argument again, but I want to note a few important points.

He goes on to list five reasons for the Fed to follow this policy.

knzn raises a good point - what price index should the Fed target? Here's Michael Woodford:

One goal of my research has been to clarify which kinds of macroeconomic stabilization objectives best serve economic welfare. ... [I]t is not immediately obvious what the conventional goals of monetary stabilization policy --- especially the nearly universal emphasis that central banks place on maintaining a low and stable inflation rate --- have to do with consumer welfare; after all, the arguments of household utility functions generally are assumed to be the quantities of various goods and services, but not their prices. Nonetheless, I have shown that in familiar classes of sticky-price dynamic stochastic general equilibrium (DSGE) models --- models that incorporate key elements of ... empirical models of the monetary transmission mechanism... --- it is possible to show that the expected utility of the representative household varies ... with ... measures of price and wage inflation on the one hand and measures of real activity relative to a (time-varying) target level of activity on the other. .... The theory clarifies both the appropriate definition of ... stabilization objectives, and the appropriate relative weights to assign to them...

The answer obtained depends, of course, on the structure of the economy. In particular, inflation variability reduces welfare because of the presence of nominal rigidities; the precise nature of these rigidities determines the appropriate form of the inflation-stabilization objective. For example, if wages are flexible ..., and price adjustments are staggered in the way assumed ... by Guillermo Calvo ..., then inflation variation results in distortions caused by the misalignment of prices that are adjusted at different times. The resulting welfare losses are proportional to the ... squared deviations of the inflation rate from zero. Other assumptions about the timing of price adjustments also imply that inflation variations reduce welfare, but with a different form of loss function...

The theory also provides important insights into the question of which price index or indexes it is more important to stabilize. Again, the answer depends on the nature of the nominal rigidities. If prices are adjusted more frequently in some sectors of the economy than in others, then the welfare-theoretic loss function puts more weight on variations in prices in the sectors where prices are stickier... This provides a theoretical basis for seeking to stabilize an appropriately defined measure of "core" inflation rather than an equally weighted price index. .... Similarly, if wages are sticky as are goods prices, as implied by many empirical ... models, then instability in the rate of growth of a broad index of nominal wages results in distortions similar to those created by variations in goods price inflation. If [adjustments in] wages are staggered ..., then the welfare-theoretic loss function includes a term proportional to the squared rate of goods price inflation and another term proportional to the squared rate of wage inflation each period. In this case, optimal policy involves a tradeoff between inflation stabilization, nominal wage growth stabilization, and output-gap stabilization...

Thus, though many people object to the Fed linking the federal funds rate to measures of core inflation (as opposed to overall inflation) and wage inflation (why slow the economy just as wages begin to catch up?), there is a theoretical basis for doing so within the class of sticky wage and price dynamic stochastic general equilibrium (DSGE) models (i.e. New Keynesian models). There are two key things about constructing an optimal index. First, the prices that are stickiest should receive the most attention (weight) in the overall index, flexible prices can take care of themselves. That is why you may want to eliminate oil and food prices, both of which are very flexible, as a first approximation to this principle. Second, the split between wage and price stickiness depends upon the relative degree of stickiness in each sector. If wages are much stickier than prices, than wages should receive more weight than prices. This is just the first point extended over both input and output prices, i.e. that sticky prices receive the most weight in the index. Woodford believes that the weight on price and wage inflation should be about equal, but that is an empirical matter and hence subject to dispute. But so long as wages do display stickiness, then they should be part of the Fed's decision rule.

Comments

[Bruce Wilder]

Do "wages" = "unit labor costs"?

Both the political optics and the practical effects would seem to turn on this question.

[eightnine2718281828mu5]

Compensation going to the top .1% should be the focus of the Fed's index; it might slow the rush of compensation to those at the top, and companies might exert just a bit of energy trying to incent those further down the pyramid.

[Michael Cain]

30 years ago when a central bank made credit cheaper, they had a pretty good idea where it would go. There were standards for mortgages and consumer credit, restrictions on international capital flows, and high transaction costs that kept most people away from stocks and commercial paper. So the credit flowed into predictable places: purchases of business equipment, added shifts, new hires. The argument that they were trying to balance economic stimulus against a broad inflation driven by lots of workers with more money in their hands made some sense.

Today, they have much less idea where that credit is going to end up. Plant investment in foreign countries? An equity bubble? Exotic derivatives based on high-risk mortgages? At some level, it doesn't matter what price index they target; unless they can be relatively sure that the cheaper money is going to flow into that index, the target is of limited worth.

[save_the_rustbelt]

So as soon as real wages start to rise for workers we have the Fed pull the string? (sarcastic interpretation)

That should really help the inequality problem (?). No, it will increase the inequality problem.

Protect the rich at all costs!

[bob mcmanus]

"Protect the rich at all costs!"

knzn has had a great series of posts recently. I have been trying to grasp the essence of Keynes, especially Ch 24, for a while, and knzn has helped, perhaps in my misunderstanding.

This could be put more diplomatically, but I suspect continuous real wage declines are part of it. Accompanied, very importantly, by high taxes on wealth, ever increasing social spending, and ever cheaper capital costs. Ever increasing marginal propensity to consume means ever increasing investment = technological advances and entrepeneurs with as little downside as possible, even zero.

Failed business ventures with almost zero costs to society. I think in such a vision marginal labor costs need to be very low, but basic needs have to be covered by gov't to a huge extent.

[knzn]

Targeting unit labor costs is kind of a compromise between targeting wages and targeting prices. The theoretical arguments probably argue more for targeting wages, which means one should allow the inflation rate to rise and fall in response (inversely) to changes in productivity growth rates. (Ideally one would want to target an index of sticky wages and prices, excluding the non-sticky ones, but I was looking for something simpler.) I think targeting just wages would be a harder sell than targeting unit labor costs, because targeting wages allows permanent changes in the inflation rate (since there can be permanent changes in the productivity growth rate), whereas targeting unit labor costs would limit changes in the inflation rate to the transient effects of external supply shocks and changes in labor's share of output.

I tried to address save_the_rustbelt's objection in the second of my linked earlier posts above. I'm recommending targeting nominal unit labor costs, so real wages should not be limited by this approach. (In theory, monetary policy can't have much affect on real wages, anyhow.) Over the past 16 years a labor cost targeting policy would have allowed nominal wages to rise a lot more than a price (inflation) targeting policy. Rusty is taking the "glass half empty" view that the Fed would have to tighten whenever wages rise. The "glass half full" view is that the Fed would keep loosening until wages do rise. I think the experience of the last 16 years suggests that the "glass half full" view is more relevant; that is, the Fed has often had to tighten before wages started to rise because it was worried about prices, and prices have risen more than wages.

[rigtsal]

Leamer (http://blog.inman.com/LeamerHousingandBusinessCycle.pdf) argues for targeting house prices (which are maximally sticky, maybe).

His argument is extremely interesting, if not altogether persuasive.

[bob mcmanus]

"I'm recommending targeting nominal unit labor costs, so real wages should not be limited by this approach."

Wouldn't nominal unit labor costs have included employer portions of health care, employer contributions to IRA's and pensions, and going back to the 80s, the employer contributions to FICA?

Does labor's share of output/productivity/prices change as an economy moves from a manufacturing to a service base? If capital has become very expensive in the last thirty years (Dow 900-13k;P/E ratios) what effect does this have on the marginal contribution of labor to productivity?

Somebody this week said China has been exporting deflation. Hell, I will just have to head to the books and articles for a month, and then to numbers. Cause I don't quite trust:"(In theory, monetary policy can't have much affect on real wages, anyhow.)" Sorry.

[paine]

this uses sticky in two directions
so adjustments only in the up direction
as we have with an inflationary secular trend
sticky wages mean lagged wage response
so to the musical question

"why slow the economy just as wages begin to catch up?"
the correct answer is
to reduce real wages
relative to
real profits interests and rents

as to the equal weight biz

pure chicken heartedness
typical ivy
no dog in the hunt neutrality

"i will not offend "the party " of either economic class "
but then the whole paradigm may have a class tilt ...eh ??

[anne]

When the economy is healthy labor costs should be rising faster than consumer prices. What I do not unerstand then is whether a Federal Reserve target of labor costs would mean higher short term interest rates than otherwise. Or, would a target of labor costs mean lower interest rates? Also, the Fed does look to labor costs and possibly too much so in setting interest rates. I am not sure what the argument is about, and the vowell-lerss KNZN evidently does not wish to explain.

[paine]

bob m

capital is cheap now relatively speaking
a high price to earnings ratio
ie a high stock price
reflects cheap capital
thru its implied low discounting rate or interest rate

this of course puts aside wild expectations in earnings growth and ponzi bigger fool effects
never confuse secondary capital markets from the key credit and equity markets
for "new " issues
its like new and old houses
the prices move in the same direction
but its about the lot values not the construction costs

if an economy thru time
has a trend toward higher capital to labor ratios
(for whatever reasons)
then labors share must be lower
if there is no off setting
opposing down trend
in the rate of return on capital

[anne]

http://knzn.blogspot.com/2007/09/revised-smoothed-unit-labor-costs.html

KNZN notes that Allan Meltzer is already worried about rising labor costs. What does this mean. Meltzer would have a perpetual recession were he a controlling Fed chair. So, if Meltzer is a reason to target labor costs in setting short term interest rates, and the objective is higher interest rates, I say phooey.

Is KNZN looking to a looser or tighter monetary policy, and why? I have no idea, beyond the intentionally obscure writings. Time for clarity.

[paine]

anne

"the Fed does look to labor costs and possibly too much so in setting interest rates"
indeed
this unit labor cost target would merely make explicit
the underlying real target objective of policy

"control the nominal wage rate growth trend
with a full pass thru productivity wage increase
as a "ceiling"
yikes !!!!
the last thirty years loom into view

sticky growth rates
can be too high or too low
wage rate growth not keeping fully up with productivity
is a sticky too low
or is it a policy induced
stick it to em type too low
thru over valued dollar and slow effective demand growth
ie
a chronic output gap
called
a necessary inflation fighting level
of chronic unemployment

-------------

unit labor costs targets would just post facto
let labor take its full "productivity gains "
in higher wages
but what if the fed wants labor share reduction ??

ie wants to keep productivity plus prices
to grow faster then wages

making t that explicit would leave
some explaining to be done
to the jobbled majority

better the present indirection
hence our policy veil ....eh ???

am i too wonky here for a sunday ???

[anne]

"I'm recommending targeting nominal unit labor costs, so real wages should not be limited by this approach."

Where did I originally read this sentence? However, a target of nominal labor costs would limit labor costs, as real as can be, since this would mean forever slower growth in an economy where labor has limited balancing power against management to begin with. What we are dealing with is further limiting wages and benefits.

[anne]

Thank you, Paine. Then, I understand, what we are dealing with is an attempt to formally have monetary policy that erodes the already eroding balance of labor against management. No wage or benefit increases never ever, for no one other than, well, we know for whom.

[ken melvin]

Labor is but a component. An ever decreasing one.

[David Beckworth]

knzn proposal is not that different than George Selgin's labor productivity norm rule. This rule would stabilize nominal wages, but allow the price level to reflect changes in productivity. I just wrote about here.

[anne]

Ah, I understand further, what we need then is a way of further undermining any remaining balance between labor and management, in this management focused economy of ours, by limiting wages. Not that management wages would be limited, because management wages are not to be considered wages.

So, we have a fancy-snooty beat-down of labor when labor is already beaten down. I say we target and hard-target fancy-dancy the costs of labor cost worriers. Say what?

[anne]

Sort of like the Seinfeld Soup-Nazi, no more soup for you becomes no more raises for you. While swallow hard them there absence of benefits, folks. No more health care for you - costs costs costs.

[David Beckworth]

Anne:

Stabilizing nominal wages does not mean further eroding labor's earnings. Quite the contrary: if the nominal wage is stabilized and productivity is growing, then the price level must be falling and that implies a higher real wage (i.e more purchasing power). Hence, labor is benefiting from the productivity gains as well.

This proposal is win-win: better stabilize macroeconomic and let labor get its fair share of real earnings.

[bob mcmanus]

"No wage or benefit increases never ever, for no one other than, well, we know for whom." ...Anne

Look, I am as left as it is possible for a sane person to be, but this is a conceivably just society.

Imagine a marginal income tax rate of 75%+, a gov't safety net that includes UHC, Social Security, a couple years unemployment insurance, good childcare, subsistence food & housing, whatever. Oh, a level of 50k per person per year.
Imagine constantly deflating prices for consumer goods.

In such cases nominal wages and the marginal labor cost for a entrepeneur starting or expanding a business could be points, dividends, capital gains. Everyone a capitalist, an entrepeneur, risking their human capital, investing everything, making capital free.

Keynes GT, Ch 24

"Thus we might aim in practice (there being nothing in this which is unattainable) at an increase in the volume of capital until it ceases to be scarce, so that the functionless investor will no longer receive a bonus; and at a scheme of direct taxation which allows the intelligence and determination and executive skill of the financier, the entrepreneur et hoc genus omne (who are certainly so fond of their craft that their labour could be obtained much cheaper than at present), to be harnessed to the service of the community on reasonable terms of reward." ...JMK GT.

WTF? The only way this makes sense to me is if the Marxian and Keynesian Utopias coincide at Full Employment, Zero Wage Labour (Costs), Free Capital(Zero Interest).

"Free Capital" in some abstruse Marxist sense(sum social relations). But, IIRC, one of the main Marxist critique of Keynes is that the conditions of the first paragraph above are not politically possible in a class-divided society. But I believe Keynes thought he had a stealth solution.

Don't mind me. I just can imagine circumstances in which declining real wages is not in itself unjust or inefficient.

[anne]

Agreed, that declining or flat real wages and benefits are unfair and inefficient but I would argue that an increased Federal Reserve focus on labor costs would further flatten real wages and benefits.

What is little understood about Japan through the deflation years, was that middle class workers were well-sustained by real raises. Japanese students repeatedly remark on a sense of well-being in Japan that growth data should have dispelled. But, the Japanese middle class has been remarkably insulated since 1990. Paul Krugman alone noticed this, but I knew this separately from travel through Japan.

[calmo]

Nibbling (I'd say "targeting" too, but that would be overkill.) [Let's B clear: this is not rocket science and any "targets" or "targeting" is fair game.] on ken's pieces today
Such a note: the declining input factor (labor)
so anemic that it must be assigned a wage
...in the end, by the officials...or those Texas janitors will embarrass us again.

So labor productivity is seen as the benchmark, the gauge, the measure of ... manager's skill: manager productivity, whose every breath is to obtain more product from less cost...let me haiku U: more machines, less labor.

But this is America...where the consumer is king and those workers (people (with bated and baiting breaths) behind that "labor") are remunerated (that unilateral process which enables consumption for those whose income streams are limited to...wages...so sad) according to...interest rates that track labor costs (the declining factor of production costs...very declining, just as soon as health care costs can be annulled as per GM).
Self-snuffing candle, no?
Context for any glut talk, no?
"Why do we have a Fed?" asks Jon Stewart. Mankiw says is a genius. aside from this preoccupation with his own brilliance, might be quite right on this one point.
No brain glut here, you?

[knzn]

Anne,

However, a target of nominal labor costs would limit labor costs, as real as can be, since this would mean forever slower growth in an economy where labor has limited balancing power against management to begin with.

If the Fed targeted labor costs at 2% instead of targeting (as data suggest maybe they have) inflation at 2% over the past 15-20 years, this would almost certainly have meant faster, not slower, growth.

...what we need then is a way of further undermining any remaining balance between labor and management, in this management focused economy of ours, by limiting wages. Not that management wages would be limited, because management wages are not to be considered wages.

First of all, management wages (not to mention bonuses and stock options) are definitely part of labor costs. Probably stock options are a large part of the reason that labor cost growth over the past 4 quarters has been rapid.

But more generally, you are taking the "glass half empty" view that a labor cost target would "limit" wages. The "glass half full" view is that it would "ensure" wage growth (up to a point). The problem over the past 15-20 years has not so much been that wage growth was limited, but that there has been almost no wage growth at all. I'm almost certain that, over this periods, a labor cost target would have been better for workers than an inflation target (which is not necessarily to say that the same will be true in the future, but I don't think the labor cost target can do much harm).

[knzn]

What is little understood about Japan through the deflation years, was that middle class workers were well-sustained by real raises.

The ones with jobs were well-sustained, but the unemployment rate also went up from around 2% to around 5%. I have a lot less sympathy for "workers" who are actually working than for people that are looking for jobs. In my social welfare function, a few percentage points of real wages for the 95% with jobs is not worth anywhere near as much as getting jobs for the other 5% (especially in Japan -- and for that matter the US -- where real wages were very high by world standards to begin with).

[knzn]

I would argue that an increased Federal Reserve focus on labor costs would further flatten real wages and benefits.

Given the likelihood of an adverse import price shock in the near future (or right now), I would agree, in the immediate context. But see my last comment. Ameliorating the condition of workers is not a good thing if it requires the creation of an underclass of people with no means of support. Given an adverse import price shock, the effect of focusing on prices rather than wages would be to weaken the economy and make jobs harder to get.

[bob mcmanus]

The Keynesian political economy has not done well these last thirty years or so. I know the Keynesians would say they haven't been in charge, but an economics that can't be implemented is pretty useless, a economic theory is supposed to change psychologies or conditions.

Keynes has had his shot, and we reverted to neo-classicism. The upcoming "supply shocks" may require or enable the kind of politics that Keynes intended to forestall.

[anne]

"Given the likelihood of an adverse import price shock in the near future (or right now), I would agree, in the immediate context."

Yes; I am dreadfully afraid for cheese, any more expensive French cheese and I may have to settle for the free slabs at Whole Foods. Cheese is my worry, the French, lacking the oil of Norway, are preparing for an American cheese war. I want my cheese.

Notice how price shocked I am.

[Blissex]

Fascinating discussion in particular because it does pierce a bit the usual veil of obfuscation and dissembling in economics.

This however starts badly:

«One goal of my research has been to clarify which kinds of macroeconomic stabilization objectives best serve economic welfare.»

Whose economic welfare? Stabilization, that is "communist" style central planning, of whose income? Because generic words like "welfare" and "macroeconomic" tend to be used to obfuscate who is going to lose and who is going to benefit.

Since inflation ''in general'' has profound distributional implications, unqualified uses of "welfare" and "macroeconomic" in any discussion of inflation look to be signs of rampant intellectual dishonesty.

«Anne: Stabilizing nominal wages does not mean further eroding labor's earnings. Quite the contrary: if the nominal wage is stabilized and productivity is growing, then the price level must be falling and that implies a higher real wage (i.e more purchasing power).»

Sure, because the assumption is that wages or nominal unit labor costs) are the stickiest prices, if one fixes those, everything else must adjust to those.

But wait a second: isn't the price of capital one of the other less sticky prices? Isn't it that if unit labor costs are kept fixed, and productivity goes up, instead of consumer good prices going down, it could be the return on capital that goes up instead?

Because I seem to remember that good and services have *two* inputs, labor and capital, and if one fixes the money price of one of the two inputs, it is indeterminate whether adjustments are made via changes in the money prices of the outputs or in that of the other input.

Even better: the shares of labor and capital depend on their relative leverage, and in practice the flexibility to adjust the money price is an important part of leverage.

As someone suggested, why not instead assume that the rents of CEOs and business owners should be kept constant in nominal terms, and trigger a recession every time they go up? Let's see what does to their leverage...

«Ameliorating the condition of workers is not a good thing if it requires the creation of an underclass of people with no means of support. Given an adverse import price shock, the effect of focusing on prices rather than wages would be to weaken the economy and make jobs harder to get.»

Oh well, "weaken the economy" is one of those unqualified generalities used in a context pregnant with distributional consequences.

And the veil about the distributional consequences is there because the consequences are there: this presupposes that there are *three* inputs: capital/rent, ''protected'' workers and ''underclass'', and that shocks should be adjusted for by reducing the leverage of the ''protected'' workers so that the ''underclass'' can compete with them for jobs, assuming that the cost of the adjustement has to fall on either category of workers.

However I understand that a french or english or german-style situation where there are ''insider'' job markets for native whites, and 'buffer''/''reserve army'' ones for immigrants brownies, may be in many ways more objectionable than one in which all workers compete for the same pools of jobs.

[anne]

KNZN

"If the Fed targeted labor costs at 2% instead of targeting (as data suggest maybe they have) inflation at 2% over the past 15-20 years, this would almost certainly have meant faster, not slower, growth."

Agreed; and here would be a powerful argument for a target on labor costs. Faster growth would of course spur employment as well. Using a labor friendly argument, I am sympathetic.

Paul Krugman suggested that the Japanese central bank should have set inflation targets in spurring growth and employment, and I agree here as well.

[anne]

KNZN, nicely done. I began with sympathy, turned sour but have turned again.

Japan would have done well to have had a 2% labor cost inflation target from 1990 on, but especially from 1994.

[Blissex]

«we reverted to neo-classicism»
Here i guess that "we" means ''the propaganda machine sponsored by business interests in the USA''.
Because in other countries neo-classicism, which is in effect whatever can be put together around the central verity that the income distribution is only and necessarily determined by productivity, has not had as much popularity as in the USA, where management productivity has been rising so fast in the past 20 years :-).

[anne]

How, then, could the Japanese bank have generated enough investment in the domestic economy to have spurred labor costs from 1994? Paul Krugman has never been convincing on the mechanism. How?

[Blissex]

«If the Fed targeted labor costs at 2% instead of targeting (as data suggest maybe they have) inflation at 2% over the past 15-20 years, this would almost certainly have meant faster, not slower, growth.»

Growth of what? Another vacuous genericity.

«Agreed; and here would be a powerful argument for a target on labor costs. Faster growth would of course spur employment as well.»

Suppose for a moment that low-end unit costs in the USA had risen faster than they have, by 2% per year, would the "growth" and "employment" have happened more in the USA or even more abroad?

And fuzzy thinking like that ignores the fundamentals of leverage.

Suppose for a moment that the modest nominal growth or fall in real terms of low end unit labor costs over the past 20 years were due to waning labor leverage, due to politics, deunionization, technology, globalization.

Now, if the Fed has a target of a 2% increase in the prices of something with a weak bargaining power, they would have had to pull all the stops in terms of monetary growth and low interest rates (instead of ''easy Al'' or ''helicopter Ben'', we would have had to have ''C-52 Galaxy Ben'').

What would the consequences of that have been? of an even lower cost of capital financing than has been the case? More growth of what? Where?

[Blissex]

anyhow most this discussion perplexes me not just because it is fuzzy as to the consequences of which inflation to control, but also because the subject of why some price levels should be smoothed is left unspoken, and instead it is one of the *two* core aspects of any such discussion (the other being the distributional impact).

So why should the Fed target inflation at all, and inflation of what? What's the rationale? After all flexible prices are good aren't they?

Well, the best approach I can think of is a Keynes-inspired one: that what is bad is large changes in the price of money in terms of other goods, and in particular accelerating rates of change in that price, and that is because money is the special good that is used both to express financial balances and to settle transactions, and sharp swerves cause trouble with expectations and liquidity, not good for business.

Problem is that is influenced very differently by the different prices of money, that in terms of units of work, or in terms of barrels of oil, or in terms of sqft of houses, or in terms of CEO leadership.

In general it is easier when most good and inputs move in the same way with respect to money; but when they don't the distributional effects matter a great deal. It is a bit too simple to say just target the price of money in terms of the good with the stable relationship with money...

[knzn]

What would the consequences of that have been? of an even lower cost of capital financing than has been the case? More growth of what? Where?

In general cheaper financing would make it cheaper to hire labor. To the extent that one can force the cost of capital down, it shifts the distribution toward labor. It's true that some of that would go to foreign labor rather than US labor, because physical capital could be created overseas but financed in the US (as has often often been the case with Japan recently). But there is still a "home bias" that would favor US labor relatively speaking. An aggressively easy monetary policy would also have weakened the dollar, which would have supported growth -- and demand for labor -- in the US by increasing demand for US products.

In general it is easier when most good and inputs move in the same way with respect to money; but when they don't the distributional effects matter a great deal.

I don't see why the distributional effects of different monetary policy targets would be very different. For example the Fed could have targeted CEO pay, and the only result would be that monetary policy would in general have had to be a lot tighter. It's not clear to me how a generally tighter monetary policy would reduce CEO pay relative to other prices. (We don't really know exactly why CEO pay has risen so much, so perhaps tighter money would have made a difference, but it's not obvious to me what direction that difference would be in.)

Note that targeting labor costs does not necessarily mean tightening "whenever labor costs go up", because there is an expected cyclical pattern which the Fed should take into account in making its forecasts. In practice, the observation that labor costs are rising at a particular time would not be a good signal to tighten, because it also tends to foreshadow a recession, which would be a reason to loosen. The question would be whether labor costs are rising more than usual for a given point in the business cycle, or perhaps whether they rise more quickly or slowly overall in one business cycle compared to the previous cycle.

[knzn]

I think I should emphasize again the difference between targeting wages and targeting labor costs. The former would shoot for a steady rate of nominal wage increase regardless of productivity. The latter would shoot for a rate of wage increase (actually, compensation increase) that would depend on the rate of productivity growth. Woodford's argument tends to support wage targeting (although maybe not, because he would want to target an index that includes both wages and sticky prices). I have argued for labor cost targeting instead, mostly on the grounds that it would make the rate of price inflation more predictable in the long run.

[paine]

magic bean moment for jobholders

"if the nominal wage is stabilized and productivity is growing, then the price level must be falling and that implies a higher real wage"

stablizing nominal wages has no direct link
to a falling price level
even stablize prices would lead
to a by de facto statute
secular growth in the economic share
going to surplus incomers

who ever said labor is an ever shrinking factor
or words to that effect

needs to buff up their input output tables

ps
even if we were foolish enough
to want a falling price level
we prolly can't mandate one
with existing public levers

[paine]

knzn

what makes you think
we don't already have de facto
unit labor cost change as the deep target ???

your suggesting this "reform "
may be 30 years behind policy reality

[paine]

" I am as left as it is possible for a sane person to be"

really ???

[paine]

this thread has tied itself in knots

[knzn]

paine makes a good point:

what makes you think
we don't already have de facto
unit labor cost change as the deep target ???

My answer is, maybe we do, but if so, that's all the more reason to make the policy explicit (which is more or less what I argue in my post to which Mark links). As it is, markets will be unsure what to expect the Fed to do in response, for example, to a crash in the dollar and a sudden increase in oil prices. If they are targeting labor costs, their response should be to do very little, because neither of these events will have much effect on labor costs. (There are indirect effects via the business cycle effects, but in my example, the business cycle effects of the oil shock and the dollar crash would probably go in different directions, and might well cancel.) However, if they ignore such events, markets will lose confidence in the Fed because they will see that the Fed is not trying to control the inflationary impact of these events. If, however, markets know in advance that the Fed is targeting labor costs, then they will not lose confidence in the Fed, because they will see that the Fed is acting in accordance with its avowed policy.

[cm]

Blissex: Projecting simplistic racial (as in skin color) considerations on European job markets is misguided. Most discrimination works by ethnic/(sub)cultural membership, which correlates with it but is a far more encompassing and arguably quite different phenomenon. Consider for example preferential treatment for people hailing from particular cities/regions, frat boys, religious or party group, family members, or members of old boys clubs. Those groups tend to be "racially" rather homogeneous, but that's not the point. Affirmative-action style stipulations can temper this only so much, and tend to target specific groups and not the general public.

And there is a more general "insider" phenomenon that is pretty much exactly the same as what "Americans" call "networking" -- preferential hiring on referral/recommendation by insiders, often to the extent that this is virtually the only way to be considered for "good" jobs.

[paine]

knzn:

i see the neutrality in your intentions

nominal unit labor cost control
is one clean and full step better
then straight up nominal wage control

but i submit
explicit suggestions about "controling "
wages even indirectly thru controling
nominal unit labor costs
is just too explicit to be politic

wage earners need to be kept disinformed about fed intentions

what better way then to appear to be guardians of householders
"cost of living " ie inflation fighters

needless to add
the role crumbles when there's an ignored reality
like rapidly rising
fuel housing and food costs
in such times --like the bush years ---
the deeper target nominal wage growth is revealed

ps
note i prefer controling to targeting
targeting is just quantified controling
some number or numbers
are always there behind the curtain
guiding the path keepers

[paine]

i might add
as a practical matter
the fed forecasts unit labor cost trends
given its "tools" lag in impact

and at least in public
this forecast is most often by based on ....
a look at the job market .....is it tightening
or loosening too fast too slow
example
fear number one on the up side
the demand for net new jobs growing too fast
and about to touch off
an acceleration
in the rate of nominal wage increases

i needn't remind u
even with a bag full of fairly careful studies
still "we " have a very poorly calibrated model
at best
of the real relationship
between raw job market dynamics
and consequent wage rate dynamics
what seems to be the rough quantitative relationship now
seems not to have existed even two cycles ago

no one has found to my knowledge
a "good looking " trend of change number for this

the trend in the changing relationship between quantity and price on job markets
prolly itself is historically "variable "

given what is at stake
even missing the beat by a very small amount
is like brain surgery with a butcher's knife
simple co-relation studies
and even simpler kinematic models
are a fools guide i fear

errrr to say the least ...eh ?

[calmo]

So, Greenspan tells us through Jon Stewart that the Fed's business is to stabilize (AG's forearms move up and down in front of him as if he is quelling a small insurrection.) [Unfortunately no longer available at Utube, possibly because it was too destabilizing...and not sexually arousing as the grannies thought.]...something more than mere prices.
Back in the rough and tumble days of the gold standard, there was much more instability (tumbling)...and this is not the calm before the catastrophe. This, Fed Era, is Progress.
Alrighty, so progressing along now, we have knzn suggesting that this layer of "inflation targeting" just needs to be understood for what it is: labor cost targeting. And as soon as the Market understands this posture represented by "inflation targeting" as this position "labor cost targeting", they (marketeers) will know that the Fed is working with them (like GM needs that comfort/support with the current UAW negotiations and the union's refusal to budge on $50B worth of previous agreements...teaching one and all that agreements with GM mean diddly...unless you are a lawyer of course) and reports that the Fed has been stacked with socialist union representatives have been somewhat exaggerated.

This is progress?
I thought the Greenspan/Stewart interview was cordial...given Stewart's affection for w/GOP and Greenspan's somewhat flexible now, view of the President. I thought I saw a glimmer of progress there.

[knzn]

FYI I put up a couple more posts on this subject here and here. The former mostly repeats, in different (hopefully clearer, but I'm not so sure) words, points that I've tried to make in these comments. The latter just tries to make the case concisely in the context of the particular US situation today.

[save_the_rustbelt]

knzn

Thanks for the response.

I just don't trust the "elite" in this country to do anything but protect the elite.

E.G., I think any bailout of the subprime mess will be focused on the rich who made bad investments, rather than the workers who lost jobs and homes.

Good dialogue here.

[calmo]

Well God bless you rusty, for this rescue: "Good dialogue here.".
I was just about to surrender to paine's "this thread has tied itself in knots".
But it was just a bowline...which are infamously "easy" to undo. (Another transparency problem, people, where the sailors don't get to write the books on sailing.)

[knzn]

save_the_rustbelt:

I just don't trust the "elite" in this country to do anything but protect the elite

I get your point, but presumably the elite would be equally untrustworthy no matter what they're targeting. Unless you can think of a way to force them to protect the interests of workers.

[knzn]

Actually, from the point of view of literally saving the rustbelt, I think labor cost targeting would be a particularly good idea, because the Fed could allow the dollar to fall without reservations and thereby make American heavy industry more competitive again.

[anne]

KNZN, after considering carefully, I agree entirely. Nicely argued, only needing a summary essay now.

[anne]

"I just don't trust the 'elite' in this country to do anything but protect the elite."

Typical meaningless rubbish; but we all know who them eliters are and we are coming for them eliters when the time comes.

[anne]

KNZN

"Actually, from the point of view of literally saving the rustbelt, I think labor cost targeting would be a particularly good idea, because the Fed could allow the dollar to fall without reservations and thereby make American heavy industry more competitive again."

Complete nonsense; making me wonder whether the rest of the argument is at all reasonable after all. All we need is a less valuable dollar and, imagine, I will turn in my Prius and learn to love the cars General Motors has fought against making for 20 years. What nonsense.

[knzn]

Anne, it's not a question of what you will do; it's a question of what marginal buyers will do. You may be adamant about owning a Prius, and some people are adamant about owning Hummers no matter how high the price of gasoline goes, but there are also a lot of people have a real decision to make about whether to own US or foreign cars. I've got a Saturn; if the dollar had been stronger, I might have bought a Toyota instead. (Though actually, I think most Toyotas sold in the US today are also manufactured in the US, so the dollar might not have been an issue for me. But that just makes my point: if the dollar is weaker, Toyota will be more likely to locate factories in the US.) I will say (though it's a minor example) that I will probably be drinking a lot more California wine in the future than I have in the past.

[paine]

knzn

i like your long range objective
i think diving toward a bottom dollar
is absolutely necessary
even if i don't share
your sense of the value of a half way house solution
ie
this switch in policy target from core inflation
to unit labor costs
i agree in a sense it could harbinge ..but
would it be the john the baptist dunking
the annointing and preparing we need
for the coming of the big dive
when uncle dollar
swans into the forex abyss ???

yes to close the trade gap
is our to be or not to be

i agree we must begin asap to
rebuild our industrial platform
and this will indeed
require an import price tsunami

but under my lights
the proper preparation
for all this
will require
a whole sale dumping
of the present fancy pants war on inflation

we gotta make it about the reallong range economy here

we gotta make it really real
we gotta make it
about rebuilding the source

about a job system
chock full of
high take home pay jobs
regular folks type jobs

one's learnable and doable with a minimum of training

rosey the riveter jobs
liberty ship jobs

i i submit
this will take a massive rallying
a call to arms
a rising up to meet a huge national challenge

lay it all out b4 the people

" at the end of this struggle
do u want a high wage economy
an economy running at high speed
toward national full court prosperity ??
then prepare for
this and this and this "

yup hit em with the up front sacrifices
the good old
"blood sweat and tears " bit
the nations millions are ready for it

the ground swell response
to that grotesque false alarm 9/11
demonstrates
and to my mind
beyond reasonable doubt

america's broad reach of people
will rise to a noble challenge

if they see our only road to national salvation
requires victory in this mission
they'll rise up

and we can dig ourselves out
from under
this trans nat debt dump

free ourselves
by getting back to basics
like producing as much as we consume
of real things

as rusty never fails to witness
we'd better and quick too
before this ever swelling
invisible mountain of iou's
becomes a burial mound

we better
rebuild the real america

if we do
it will be like nothing
we've done
since the days
when we transformed ourselves
into
the arsenal of democracy

[anne]

KNZN

"I think most Toyotas sold in the US today are also manufactured in the US, so the dollar might not have been an issue for me."

Precisely; increases in the value of a currency should simply result in competitive businesses becoming more so and compensating for cost differences. With healthy domestic economies, European companies have been adjusting for a strong Euro for all the complaining. Similarly for Australia and interestingly Brazil. American companies became increasingly competitive through the 1990s as the dollar strengthened. The value of the dollar is not the reason Toyota is so competitive, rather Toyota has worked for several decades to be competitive regardless of the value of the dollar.

[paine]

anne
i take it the key word here for you is ...competitive

well if to be competitive is to at least tie the other side
we're losing the trade game ...big time losing
by a score of about
two and a half trilllllion for them
to
one and three quarters trilllllion for us
(give or take a couple three hundred billion
on either or both sides )

that's net losing
right now and for some time now
no amount of specialization
in high vale added PRODUCTS
financial services
cutting edge biomedical R and D
and other high yield IP freely's
has managed to close

our total value added don't add up to
their total value added
trade balance becomes whimpynomics
"i'll gladly trade you IP tuesday 2020
for a flat screen today "

got a solution
or is our trade gap of 800 billion
and our vanishing industrial base
not a "real " problem ???

[paine]

schumpeter update
creative destruction goes trans national
industrial division of phases

we keep the destruction
china gets the creation

[knzn]

anne:

...increases in the value of a currency should simply result in competitive businesses becoming more so and compensating for cost differences

That just doesn't make sense. It's true that management quality matters, but for any given quality of management, the lower their costs are, the more they can profitably produce. Your view seems to be that good management operates by achieving a minimum acceptable level of profitability, and if you raise their costs, they have to become more efficient so they can once again rise to that minimum acceptable level. I think good management seeks to maximize profitability, even when their costs are already low. If Europeans had to become more efficient because of the strong euro, it means they weren't doing a very good job to begin with. Eventually, if the euro continues to strengthen, they'll get to the point where there is no more inefficiency left to squeeze out, and then even relatively inefficient Americans will be competitive.

In principle, whether American cars say "GM" or "Toyota" on them, they're still made in America. Perhaps a weak dollar will cause foreign capitalists to produce more in the US, but it doesn't make a great deal of difference to me who the bosses are, as long as they are employing American workers. A weak dollar will also slow the rate of offshoring from the US, as the cost advantage is reduced and other considerations start to outweigh it.

American companies became increasingly competitive through the 1990s as the dollar strengthened.

The dollar strengthened largely because American companies were becoming more competitive; the causation goes in both directions and determines an equilibrium. In the late 1980s, though, the causation went the other way: American companies revived because the dollar stopped being so strong.

[knzn]

It was a strong dollar that got us into this mess in the first place, back in the early 80s. I think that's when the term "rust belt" came into use. That's when unemployed auto workers were smashing imported cars. The strong dollar did in US manufacturing, and it has never really recovered. US manufacturing employment reached its all-time peak in 1979 (at the end of a decade largely characterized by a weakening dollar).

[baileyman]

The Fed SAYS "inflation" but it DOES "wage suppression". Usually. Right now it SAYS "inflation" but it's DOING "devaluation". After the devaluation is DONE, it'll be back to DOING "wage suppression" since DOING "devaluation" risks losing what it sees as the gains from previously DONE "wage suppression".

[paine]

knzn

your response to anne
was very strongand to my liking
no chauvinistic

i agree
the boss and his/her board of directors
can be from anywhere and stay there
for all i care
but more jobs actually producing
our home bought junk
must be jobs that are located here

to at least
the point where our product trade balances

services ...seperate accounting needed
and care picking thru
to cull out the rents

i hope anne absorbs your stuff

maybe she'll see the high dollar devils
in their proper light

btw i'd comment at your site
but it takes too damn long
to get the page open

i'm ignorant as a pig about sunday services
when it comes to blog formats
but my adhd requires fast click results

[paine]

bail

you have a keen sense of it all

the term "real wage resistence"
comes to mind

ie

yes labors household real income
will be negatively wacked
by the low dollar effect on imported
household products

but if we have an export /import sub type boom
jobs might get scarce and real wafe rates rise

the whole red herring about inflation
as an enemy of the job class must be smashed affor hand
or we'll have ben firing up
volcker dammerung II