Relative Prices and Recovery


Welcome back to the blog that started it all for me. I doubt anyone has this blog left on their RSS feed, but this will be my home for a while until I decide to get a domain back. It’s been a tumultuous last couple years for me, but I’m happy to get back into blogging.

Moving forward, I came across an article by Lawrence Mishel and Nicholas Finio, posted yesterday, about the movements in inequality during the recession.

As it turns out, the top 1% are about 8.6% below their earnings peak in 2007. During the same time, the wages of the bottom 90% have fallen, and continued to fall during the recovery.

On nearly every level, this shouldn’t be too surprising. The income composition of the top 1% and the bottom 90% differ radically, as does the actual composition that makes up the 1%…whereas the 90% income group is fairly robust (necessarily, it is much larger).

Now, how does the two groups’ incomes differ? Well, besides wage compensation differences, the 1% derive much of their income through capital gains and fixed assets. Because these markets are volatile, they are able to respond with great elasticity to small changes in NGDP growth. On the other side of the coin, the 90% derive the vast majority of their income from wage earnings. Wages are much slower to adjust to changes in NGDP…and are especially sticky downward.

So what would we expect to find given a rise in money demand not accommodated by the Fed causing a large fall in NGDP? Well, we would expect a wide swath of asset classes to experience large price declines, and thus a stark fall in returns on those assets. We would also expect to find a high level of unemployment, which would only marginally affect aggregate wage earnings. Check out 2007-2009 on the above chart. What do you see?

Moving forward, suppose the Fed stopped the worst of the bleeding, but never allowed NGDP to return to trend. What would we expect to see? Well, a large rise in the value of a wide variety of asset classes as investors regained their appetite for risk, and thus a relatively large rise in return on those assets. On wages, we would expect to see prices slowly adjust to the new (lower) trend rate of NGDP growth. Relative prices would adjust slowly as employers rebalanced their portfolios between capital investments and new labor. First, you have the lingering of old wage contracts raising the average reservation wages in various compensation classes. Second, you have larger investments in capital goods, which raises some labor’s marginal product (I would expect these people to be the 90-95%’ers in the chart above. check out their stats!), but likely not enough to compensate for a larger fall in the marginal product of other labor. You would expect to see a slow grind downward toward a new equilibrium. Check out 2009-2011 on the chart above. What do you see?

Rich wage earners, who are indirectly compensated (i.e. like doctors) did well all around.

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3 thoughts on “Relative Prices and Recovery

  1. “Moving forward, suppose the Fed stopped the worst of the bleeding, but never allowed NGDP to return to trend.”

    Are you talking about the Quantitative Easing measures? Also, would a small percentage hike in inflation(possibly in addition to the QE measures) have helped NGDP get back to the trend line?

    I can’t help but think if inflation were higher it would devalue the dollar…true? Does the Yuan’s ties with the dollar “prevent” the US from adjusting its inflation rate?

    I think I followed most of the article and enjoyed the sticky wages link! These were just my thoughts and questions afterward.

    1. QE is the particular tool the Fed used once short term interest rates hit zero, but I don’t think it is a particularly effective tool, especially as implemented currently throughout the world — with little to no expectations management. Although the Fed has gotten better on that recently.

      As far as returning to trend, it would most likely involve a period of above-trend inflation, though theoretically that would not have to be the case.

      Yes, a higher rate of inflation would devalue the dollar, and that is good! A dollar that is more rapidly depreciating than was expected causes portfolio rebalancing away from safe/low-yield assets, which is what we want. If you’re into national income accounting (which I am not) it would boost I and (X-M). The Yuan peg doesn’t prevent the US from inflating — in fact, there has never been an example of a fiat money central bank trying and failing to create inflation. Sans adjusting the peg, however, USD devaluation does create inflationary pressure in the Chinese economy…but they’re the one’s pegging, so that’s their problem.

      1. “As far as returning to trend, it would most likely involve a period of above-trend inflation…” Would this be considered inflation targeting by the fed?

        I’m going to have to read up on the difference between NGDP targeting and how that works compared to inflation targeting. Also, will delve back into some accounting stuff out of curiosity.

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