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Wednesday, December 20, 2006

Does Ben Bernanke Think You Should Get a Raise?

There's been a little bit of discussion lately about whether inflation targeting holds down real wages and favors the interests of business over labor. For instance, Dean Baker wrote recently that:

[T]he most annoying part of the article is the comment, "wages have risen so swiftly that some economists worry that they could push inflation up." This is true, economists (including Federal Reserve Board chairman Ben Bernanke) are very worried about wage growth, but it would have been worth noting the implication of this statement. It implies that some economists believe that it is unacceptable for workers to enjoy any wage gains - as soon as they start to experience wage gains, inflation is a problem.

Many economists (perhaps most) hold a view like this, but the public should be aware of this issue because it raises fundamental questions about economic policy. Is the Federal Reserve Board always going to turn off economic growth whenever the labor market tightens enough so that workers can benefit? If this is the policy, shouldn't the people know?

See the comments to this recent post for more examples of this sentiment regarding Fed policy.

I've thinking about how to follow-up. This piece by Paul Krugman is a good start. It's from 1999, but the issues are very similar:

Labor Pains, by Paul Krugman:  Alan Greenspan doesn't think you should get a raise. And he doesn't want you to feel too secure in your job, because otherwise you might demand that raise. I'm not putting words in his mouth. A few weeks ago, addressing an audience of bankers, the usually Delphic chairman of the Federal Reserve Board was uncharacteristically clear, warning that the United States economy is ''steadily depleting the pool of available workers'' -- that is, giving jobs to the previously unemployed. As a result, ''labor market conditions can become so tight that the rise in nominal wages will start increasingly outpacing the gains in labor productivity'' -- that is, workers who know that jobs are plentiful will get big raises.

And that, Greenspan implied, would be a very bad thing. He didn't say what he would do about it, but markets got the hint: bond prices immediately plunged, on fears that the Fed would soon raise interest rates. Now to a man from Mars -- or for that matter to a normal human being -- Greenspan's concerns might sound very peculiar. After all, what's wrong with giving jobs to the jobless and higher wages to the employed? But Greenspan is probably right to be worried. What is less clear is whether it was a good idea for him to be so explicit.

Think of it this way. Once upon a time (say, back in the mid-70's, when Gerald Ford was President and Alan Greenspan was his chief economist), the U.S. economy was like a trendy restaurant -- one of those places where the tables are set close together and the ceiling seems custom-designed to maximize the din. What happens in that kind of environment is that everyone tries to talk above the background noise so as to be heard by his or her companions. But by talking louder, you yourself raise the noise level, forcing everyone else to talk louder, praising the noise level still further, and eventually everyone is shouting themselves hoarse. Substitute wage and price increases for speaking volume and inflation for the overall noise level, and you have a capsule analysis of the kind of inflationary spiral that the U.S. faced in the 1970's. And the only way that the noise level (inflation) could be kept under control was to keep a substantial number of tables vacant -- that is, by maintaining a large reserve army of unemployed.

Today, of course, the situation is vastly improved. The economy is flourishing, with unemployment at a 25-year low. (The restaurant is full again.) Yet so far inflation is quiescent. (The noise level is tolerable.) This is partly because exceptional productivity gains have made it possible for companies to pay higher wages without raising prices. (A sound-absorbing ceiling?) But it is also because, for reasons that nobody fully understands, workers have been remarkably diffident about demanding higher wages, even in the face of labor shortages. (Diners have mysteriously become more polite?) Everyone is happy. But will the very exuberance of the diners bring the bad old days back?

That's what Greenspan is worried about. What he said to the bankers was, in effect, that no matter how good the acoustics, no matter how well behaved the customers, if the restaurant gets sufficiently crowded there will be a shouting match. And if that happens -- well, he'll just have to limit the number of patrons. It's not that he is mean-spirited or a tool of capitalist oppression; he's just doing his job. But you still have to wonder whether it was a good idea to describe that job so explicitly and so honestly.

    Posted by on Wednesday, December 20, 2006 at 12:15 AM in Economics, Monetary Policy, Unemployment | Permalink  TrackBack (0)  Comments (16)


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