Saturday, November 16, 2013

In praise of wage inflation!!!!

"Wage inflation". The very words strike terror into the hearts of economists and financiers everywhere. We are taught that wage inflation is categorically evil, as if some comprehensive set of data proved this beyond any doubt. But, maybe there is a time and place for wage inflation, and maybe that time is now and that place is here.

A primary goal of the government today should be to stimulate the economy to, in principle, cause hiring to create additional GDP. US companies are sitting on record balances of cash, so they have no problem funding capital expansion and hiring. The low interest rates may help them on current interest payments by some refinancing, but otherwise makes not difference to them. They see no demand for more goods and services beyond what they currently plan to produce, so they sit and wait. They are waiting to be signaled by consumers to increase production by consumers buying more goods and services than these companies are currently planning for. This is the demand signal that moves companies to hire workers and invest in capital expansion.

Consumers, seeing their pay stagnate or shrink, and being up to their ears in debt, are in no position to increase their spending to create the demand needed to signal companies. So, they muddle through hoping not to loose the jobs they have and become one of the tens of millions of unemployed.

The long-term unemployed try to find work, but are unable. Neither are they in much of a position to start businesses of their own. I suppose some try to do odd jobs or deal things at flea market and on line. But they just hope to find some decent job before their unemployment runs out. BTW, unemployment insurance payment is the one fiscal stimulus that is actually in effect to boost demand.

I believe this whole line of argument is the one Keynes made to justify government intervention in the first place. And that fiscal policy is needed during recessions.

Consumers are spending all they can afford to, but that level is below the amount that the businesses in the economy are structured to produce. The lack of growth in the economy is because the consumer isn't buying more. And the consumer isn't buying more because they lack the income to do so. In other words, incomes have not kept up with expectations of producers. So, production is cut back to a level that consumers can currently afford. This means the supply and demand curve is moved to lower demand and thus lower supply at a lower price. This is source of the lack of inflation that we've been seeing.

What is needed is for consumers incomes to grow, which would spur purchasing, which would spur increased production, which would spur hiring and capital expansion. Which would...increase incomes. This is, in fact, wage inflation. Prices would necessarily rise as demand is bid up by rising incomes, and rising supply would only happen if prices were bid up to motivate the increase in production.

The happy side effects of this wage inflation are: lowered unemployment, raised taxes, and likely increases in long term profits for companies as those sales increases accrue over the years. This is a much better situation for all then if those unemployed stay idle, government deficits continue at the current pace, and production at companies remain below the potential output.

Going back to Keynes, this is where the government needs to step in. How to achieve wage inflation? By cutting taxes on wage earners. I.e. those folks who make their incomes through work producing real goods and services. Also known as the middle class and the working class. The groups who have been taking the brunt of the economic crisis. One which they largely didn't create. How to pay for this? By increasing taxes on those who benefit by increased incomes from unproductive activities. I.e. Wall St types and those who's incomes come from rents and capital gains. This isn't a punitive suggestion, merely a recognition that the wealth is flowing to those groups and they are not spending it to produce increased demand for the goods and services that the nation's companies are set up to produce. Such a trade off of taxes would be essentially revenue neutral, but would increase demand in the economy and send it back to full production and employment.

Such a suggestion goes against the entire "cut taxes on job creators and the wealthy" arguments.  But, I think that those arguments were weak to begin with, and have now been largely discredited by the current economic and financial crisis.  Will government have the will to make these changes?  Will the economics profession have the will to acknowledge these new policies are the correct ones to make?  Only time will tell.


  1. David, I found your blog after following your posted link at the WAPO blog by Dylan Mathews on electronic money. I've read many of the posts on the current page and just want to say that I find your ideas very interesting (in a good way) and your writing to be very clear and descriptive, better than most who cover some of these same topics. That these topics are of interest to a trained physicist and techno-guy is similarly interesting. I'm a biologist who is a novice in macro economic areas, but has considerable interest.

    I do see a number of typos in your text that are a little irritating (using "then" instead of "than", using the word "boarder" about half the time when you mean "border"). Spell-check doesn't catch these kinds of errors, so you're kinda off the hook perhaps.

    Hope you keep posting, I'll be back.

    1. Hi Tom,

      Thanks for your comments. I've also found that many who write about economics use obfuscation that makes them hard to understand. Sometimes I wonder if that's by intent. So, I'm trying to convey concepts and ideas as clearly as possible.

      I'm afraid that my writing is not always grammatically correct although I do try. Often I'm cranking out text in a rush, as I'm perpetually short of time. I think I need and editor. ;)

  2. Same as Tom in Tempe, I arrived here after following the link from your post at the electronic money article. Simply worded, clear and to the point arguments make this post much easier to comprehend for non-finance people, . Would definitely like to see more of these writings for economics and finance topics.