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Sticky Wages and “Living Standards”

Why does employment fall when there is a negative shock to aggregate demand?  Because nominal wages are sticky.  Why does employment rise when there is a positive shock to aggregate demand?  Because nominal wages are sticky.

Labour and HM Treasury are arguing about whether British living standards are rising based on some measure of real wages, and I find this very annoying.

The phrase “cost of living crisis” is still stupid.  Labour spent most of the last three years arguing that the government should be doing more aggressive demand stimulus.  Well, guess what the effect of faster AD growth would be, Dear Eds?  That’s right, an even faster rise in the “cost of living”.  And because nominal wages are sticky that would mean even lower real wages… oh and hopefully, even higher employment.  That is the point in doing demand stimulus.

That’s what Abenomics is trying to achieve in Japan, following bog standard New Keynesian macro policy for the ZLB.  That’s what happened when FDR and Chamberlain left the gold standard in the 1930s, it raised “the cost of living.”  The reason “Old New Keynesians” argue we need fiscal stimulus at the ZLB is to “create inflationary pressure” because you think you monetary policy can’t “get traction”.  Yet the Two Eds are arguing UK has “too much inflationary pressure” even WITHOUT fiscal stimulus… so just what was the point of all those “too far, too fast” arguments?  Why does anybody still take this garbage seriously? 

And HM Treasury’s argument that we should look at real wages to see whether living standards are rising is just as stupid.  Almost any available measure of real wages rose in 2009… so was that good for “hardworking people” (™ The Tory Party)?  Only if you ignore the inconvenient fact that a million people discovered they were suddenly unable to work at all, whether “hard” or not.

This data is sufficient to demonstrate, in my view, that “living standards” are rising:

Month Unemployment
Rate (%)
2013 Jun 7.7 29.8
2013 Jul 7.7 29.9
2013 Aug 7.6 30.0
2013 Sep 7.4 30.1
2013 Oct 7.1 30.2

Now enough stupid arguments, and get people back to work.

Categories: Inflation
  1. W. Peden
    January 24, 2014 at 21:05

    Great post. And no-one knows what “the cost of living means” in this debate. Is it the price level? The price level of what most people tend to spend on? The price level accounting for changes in incomes? The price level account for changes in taxes? The price level accounting for changes in taxes AND benefits?

    So we have a debate about how to deal with a crisis that is undefined, produced by policies that all parties want, and with no-one (as far as I can tell?) talking to some economists and getting some solid research on the outcomes of different policies to address said opaque crisis.

    Not since the 1970s inflation was blamed on decimilisation and membership of the EEC have the UK economic battlegrounds been so myopic.

    • January 24, 2014 at 23:45

      Sometimes I think it means “prices”. But I heard Balls on the radio earlier this month and he linked it to the deficit:

      “the reason why there is a cost of living crisis is also the reason why the deficit has not come down” http://www.edballs.co.uk/blog/?p=4727

      Actually the only way to make sense of that is “supply-side fiscalism”.

      1. Fiscal policy creates negative shock to AS
      2. BoE is forced to reduce ΔNGDP to hit CPI target
      3. Reduction in ΔNGDP raises the deficit

      e.g. the VAT rise. It’s not about spending cuts and falling AD.

      I suspect there is no need to over-analyse it. It’s a catchy political slogan with little to do with economics.

  2. January 24, 2014 at 22:49

    Would the two Eds be happier if workers remained unemployed receiving inflation-linked increases in their benefits, thus keeping pace with the “cost of living”? And the challenge of pricing them back to work can wait until the recovery. It will be a long wait.

    • January 24, 2014 at 23:59

      Exactly! Oh and Osborne of all people wants a minimum wage rise too. That willl help!

  3. W. Peden
    January 24, 2014 at 23:14

    James in London,

    I don’t know, but I do know that they have every interest in avoiding people recognising the actual set of alternatives available.

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