Real Wage Readjustments Are Best Handled Through Monetary Policy

Steven Pearlstein has an intelligent reply to my post on his advocacy of nominal wage cuts as the best path out of the economic ditch.

Greek protestors in 2008 (cc photo by murplejane)

I don’t really disagree with anything he says, but I do disagree with the idea that we should focus on this. The fact of the matter is that organizing nominal wage cuts is very difficult. Examples of the difficulty of organizing nominal wage reductions often come from unionized industries, but it should be pointed out that this is largely because unionization makes it logistically easier for firms to undertake nominal wage cuts rather than mass layoffs. The logistical problems because exponentially more difficult when you’re not talking about a single firm, but instead to the idea of across the board sector-by-sector wage adjustments. An old-school social democracy could, in theory, handle this with a giant meeting between union leaders and business executives but that’s not the USA and the politics are ugly. What’s more, you’d be looking at one heck of a planning problem. In tradable sectors an accountant can sit down and do the math but trade is a relatively small part of the US economy and there’s plenty of reason to think real wages are too high in many not-so-tradable sectors (and I would, in fact, include newspaper columnists in this category) where it’s hard to figure out the “right” level on the back of the envelop.

But note that in that last sentence I switched between discussing “nominal wages” and “real wages” and this is the key to the whole thing. In Pearlstein’s case for lower nominal wages the benefits are stemming from the fact that lower nominal wages lead to lower real wages. But you could also achieve this outcome by raising the price level. The politics of this are also a bit ugly but the logistics are much better. You don’t need to say to any firm, individual, union, professional association, or anyone else and say “your real wages are too high.” Instead, the rise in the price level will let the wage adjustments sort out on their own—fields where real wages are too high will see flat nominal wages, and in fields where real wages are fine there will be nominal pay increases. You don’t need an omniscient planner, you don’t need to hurt anyone’s feelings, and you avoid the debt-deflation problems associated with adjusting entirely on the wage side.

Spain, Greece, Portugal, and Ireland signed away their freedom to make monetary policy in order to get themselves 10 years of low borrowing costs. They have no choice but to go the Pearlstein route and it’s a hard road to travel. We can get the same impact faster and better by having the Federal Reserve do its job.