A staple argument of right-wing opponents of monetary expansion to increase prices and nominal income is that, given high unemployment, inflation will not increase nominal wages, so that increasing prices must reduce real wages. This response is classic faux populism at its worst, as practiced with consummate hypocrisy by the Wall Street Journal editorial page.
What makes this argument so disreputable is not just the obviously insincere pretense of concern for the welfare of the working class, but the dishonest implication that employment in a recession or depression can be increased without an, at least temporary, reduction in real wages. Rising unemployment during a contraction implies that real wages are, in some sense, too high, so that a falling real wage tends to be a characteristic of any recovery, at least in its early stages. The only question is whether the falling real wage is brought about through prices rising faster than wages or by wages falling faster than prices. If the Wall Street Journal and other opponents of rising prices don’t want prices to erode real wages, they are ipso facto in favor of falling money wages.
Here is how Ludwig von Mises, with his unique gift for understatement, put it in his magnum opus, Human Action (3rd ed., p. 789), explaining the connection between real wages and unemployment in the Great Depression.
In the boom period that ended in 1929 labor unions succeeded in almost all countries in enforcing wage rates higher than those which the market, if manipulated only by migration barriers, would have determined. These wage rates already produced in many countries institutional unemployment of a considerable amount while credit expansion was still going on at an accelerated pace. When finally the inescapable depression came and commodity prices began to drop, the labor unions, firmly supported by the governments, even by those disparaged as anti-labor, clung stubbornly to their high-wages policy. They either flatly denied permission for any cut in nominal wage rates or conceded only insufficient cuts. The result was a tremendous increase in institutional unemployment. (On the other hand, those workers who retained their jobs improved their standard of living as their hourly real wages went up.) The burden of unemployment doles became unbearable. The millions of unemployed were a serious menace to domestic peace. The industrial countries were haunted by the specter of revolution. But the union leaders were intractable, and no statesman had the courage to challenge them openly.
In this plight the frightened rulers bethought themselves of a makeshift long since recommended by inflationist doctrinaires. As unions objected to an adjustment of wages to the state of the money relation and commodity prices to the height of wage rates. As they saw it, it was not wage rates that were too high; their own nation’s monetary unit was overvalued in terms of gold and foreign exchange and had to be readjusted. Devaluation was the panacea.
Mises actually describes the situation fairly accurately, if allowance is made for his political extremism and insane anti-inflationism, as if devaluation, in the face of 5 to 10% annual deflation from 1930 to 1933, were the problem not the solution. So if the Wall Street Journal and other opponents of monetary expansion to raise prices and nominal GDP don’t want rising prices to erode real wages, they need to explain how employment is supposed to expand after a depression without a fall in real wages. If they can’t do that, then, by the laws of arithmetic, they, like their hero Ludwig von Mises, must be in favor cutting nominal wages.
Uneasy Money 
the dishonest implication that employment in a recession or depression can be increased without an, at least temporary, reduction in real wages. Rising unemployment during a contraction implies that real wages are, in some sense, too high
It’s not dishonest. It’s true. In or out of a recession, employment can increase without a fall in real wages. Indeed, it almost always does.
The positive — NOT negative — relationship between real wages and employment rates is one of the better established empirical regularities in macroeconomics.
It is certainly true that in some simple models often taught in economics classes, the marginal product of labor is declining and the real wage is equal to the marginal product, so that in the short run employment cannot rise without a fall in the real wage. But those models are not descriptive of any actual economy.
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David
Don´t forget to link to the specific WSJ piece you refer to
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I should add, it may well be true that in the 19th century, larger cyclical price movements did result in falling real wages in some periods of rising employment. So Mises wasn’t entirely wrong … for the economy of a century ago. Not a good guide to today’s economy, though. Standard reference is Oswald and Blanchflower, The Wage Curve. The microeconomic story is that wages are set through some (formal or informal) bargaining, or an efficiency wage process, not by marginal product (which anyway isn’t falling over the normal range of output.)
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Crocodile tears indeed. The standard example of crocodile tears are the conservative admonishments that inflation hurts the poorest members of society most, for example those on fixed incomes. Hmmm…
I don’t think people in a position to collect fixed incomes qualify as the poorest members of society. I’d say debtors, unemployed, and homeless are the poorest, and none of them get hurt by inflation.
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David,
The Mises excerpt is ironic in light of the current experience. Real wages during the GD spiked; today, they have been stagnant for ten years and are recently falling. The two periods are not comparable in this sense. You can, of course, argue that unemployment is evidence that the equilibrium wage is lower than today’s. However, it is not possible to argue that we need to work off the effects of rising real wages.
A priori all we know about falling real wages is that: 1) they may increase demand for labor; and 2) they may negatively impact the “animal spirits” of those already employed, and so restrain household spending. There seems to be an assumption that the second item is somehow unworthy of consideration. This is difficult to comprehend.
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“You can, of course, argue that unemployment is evidence that the equilibrium wage is lower than today’s. ”
Yes. Of course, in a trashed economy, the equilibrium wage would probably decrease, so this argument isn’t all that meaningful.
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As you point out real wages MUST fall. The only question is the method.
That the WSJ favors general price stability over inflation is not an argument against the fact that wages must fall. That wages must fall is not an attack on the working man because as you point out real wages MUST fall.
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I’d say debtors, unemployed, and homeless are the poorest, and none of them get hurt by inflation.
In the 60s panhandlers asked for quarters. Now they ask for dollars.
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When employment is below capacity then there are 2 ways that demand for labor can be increased.
– Reduce real wages (via inflation or nominal-wage cuts) and so increase profit margins and the demand for labor. Once the economy is back to equilibrium (unless the natural rate of interest has changes) real wages would probably be back to where they were before the downturn.
– Increase AD by increasing the money supply. This will move supply along the AS curve and (depending upon its shape) cause a combination of increased production (and demand for labor) and rising prices (including wages). In this scenario I do not see why real wages would necessarily fall at all.
So I don’t see why any reduction in real wages would be more than temporary
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I’ve had a lot of success getting through to people using this analogy:
Suppose you are making an income of 60k a year. You take on a mortgage of 200k, with a payment of $1000/Mo.
If the price level and your income are both halved, are you richer or poorer than you were? Now, suppose the price level and your income both double. Are you richer or poorer than you were?
People get it when it’s put that way, and because many people have, or hope to have, mortgages, it hits home emotionally, rather than being some dry example from an econ textbook with bunches of charts and graphs and formulae. It explains exactly the choice we have here, although in reality, of course, you only have a choice if you’re A) Aware of it; and B) Willing to take it.
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“if allowance is made for his political extremism and insane anti-inflationism”
My problem with Mises is that these qualities always seem central to his work, rather than eccentricities that can be separated out from it. The story about the Mont Pelerin meeting doesn’t help.
I have in the made exactly the argument that you are making, David, in disagreemennts with Misesian types. The recent strong assertions of some left-oriented economists that lowering wages in a recession will not decrease unemployment has made me wonder if I ought to reconsider. It is just amazing how much prominent economists disagree about seemingly the most basic and essential questions in macro.
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Apologies for the typos.
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An increase in the demand for labor will increase employment and push up wages. But when the demand for labor drops, wages often fail to drop in response. And so the average wage of those employed tends to go up. You should see Scott Sumner’s graph on detrended inverse real wages and industrial output.
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I haven’t really read much (historically) about groups of individuals agreeing to lowered wages, in spite of the option it is held up to be. However, I am aware of historical instances in which groups refused to lower their wages and therefore were not substantially reemployed, as could happen now in the construction sector as it moves toward more efficient production technology.
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David—My hat is off to you on the first paragraph and this entire blog entry. Now you are hitting like a ton of bricks, and it is fun to read.
I wholeheartedly concur—to read op-eds in which the WSJ suddenly becomes acutely concerned about maintaining workers wages is just…well, really, really annoying (on top of everything, the WSJ is wrong macro-economically speaking, as you say. To help a recovery, workers either take nominal wage cuts, or inflationary wage cuts.
It is great to see a Market Monetarist takes the gloves off, and wade in.
We cannot let those with a peevish fixation on inflation call the shots on monetary policy.
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JW, I am aware that there is a debate about whether real wages fluctuate pro-cyclically or anti-cyclically. I didn’t want to get involved in that debate and attempted to side-step it by referring to a possibly temporary reduction in real wages at the start of the recovery. There is a sort of identification problem here which reminds me of the problem about whether low interest rates in a depression are an indication of easy or tight money. My view is that in a partial equilibrium sense at least unemployment is telling us that real wages need to fall. As a recovery proceeds increased utilization of capital will raise the marginal product of labor so that real wages rise along with employment.
Wonks Anonymous, Do you have a link to Scott’s graph?
Marcus, The post was triggered by Kelly Evans, but she doesn’t write for the editorial page, and she already has taken enough hits, so I didn’t want to pile on, and I was too lazy to search for previous instances of the argument on the Journal editorial page. Sorry.
Steve, Lots of crocodile tears to go around.
David, I agree that the behavior of real wages this time doesn’t match what happened in the Great Depression. But we have 10% unemployment not 30%. You are right that there could be perverse effects of inflation on consumer confidence, but you can usually come up with alternative scenarios which give you opposite effects. I personally think the pessimistic scenario about the effect of falling real wages is, in many (certainly not all, but you know which ones I mean) cases advanced in bad faith.
Barry, The true equilibrium wage could be higher than today’s, but there may not be a path to that higher wage that doesn’t involve a falling wage over some interval.
M. Simon, But only temporarily.
Rob, Precisely.
MG, Good analogy, but Irving Fisher beat you to it.
Will, No question about it, Mises was a piece of work. What story about the Mont Pelerin Society are you referring to?
Becky, Keynes has a good discussion of why it doesn’t make sense for individual workers to accept lower wages to keep their jobs in a recession. It’s not perfect, but he makes some very good points.
Benjamin, Sometimes your writing really improves if you are really annoyed.
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David, I’m referring to this anecdote, which is based entirely on the testimony of one Milton Friedman. I have never seen any indication that Friedman was dishonest in his interviews:
MILTON FRIEDMAN [on Mises]: Oh, yes, he did. Yes, in the middle of a debate on the subject of distribution of income, in which you had people who you would hardly call socialist or egalitarian—people like Lionel Robbins, like George Stigler, like Frank Knight, like myself—Mises got up and said, “You’re all a bunch of socialists,” and walked right out of the room. (laughs) But Mises was a person of very strong views and rather intolerant about any differences of opinion.
I have a friend of the Austrian persuasion (and he’s doing very well airing his opinion) who declares Friedman a socialist, and Hayek a full-blown communist. I differ sharply; though I am not ideologically in sync with either Friedman or Hayek, I respect them and have the attitude that I can learn from them.
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Right. But short-run fluctuations in employment are almost entirely driven by changes in demand. So it is wrong to say, as David does, that reducing unemployment necessarily (or even typically) requires lower real wages.
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I am aware that there is a debate about whether real wages fluctuate pro-cyclically or anti-cyclically. I didn’t want to get involved in that debate and attempted to side-step it
But you didn’t sidestep it. You took a very strong position on it, by stating that real wages *must* fall if employment is to rise. If there are historical examples — and there are many — of employment recovering without even a temporary fall in real wages, then your claim is false.
Of course the WSJ editorial is objectionable for other reasons.
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JW, Well perhaps I tried and failed, but let me try again. Let us stipulate that the data show that real wages fluctuate pro-cyclically. I want to say that even if that is the case, i.e., that real wages fall in a recession, they are, in some sense, falling less than “market forces” would dictate. (There is a lot of verbal unpacking necessary in that sentence and I am not even going to try to do it.) So inflation in the downturn would amplify the real wage reduction in the short term, but by promoting recovery would actually cause the real wage to start rising again before the the recovery got very far along. The empirical observation that wage rates fluctuate procyclically cannot tell us how a deeper cut in the real wage (brought about by rising output prices) during the recession would affect the duration of the recession and the strength of the recovery.
Will, Yeah, I think I have heard or read about that story. Mises was clearly a nut. He was, for example, a member of the advisory board of the John Birch Society, OMG the JOHN BIRCH SOCIETY. I think he stopped talking to his student Fritz Machlup, because Machlup betrayed him by becoming a Keynesian. Machlup of course never became a Keynesian, but he was willing to adopt Keynesian terminology in his writings. For Mises that was an unforgivable offense. I think he also cut off contact with Haberler for the same reason. He maintained good relations with Hayek, despite disapproving of Hayek’s accommodationist tendencies. Ayn Rand, who, for a while at least, was on good terms with Mises, absolutely detested Hayek, viewing him as worse than a Keynesian. True-blue Misesians probably feel the same way, but tend to say so only in private because they find it useful to free ride off of Hayek’s reputation. But sometimes, they just can’t hide their true feelings about him.
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even if that is the case, i.e., that real wages fall in a recession, they are, in some sense, falling less than “market forces” would dictate.
No.
Wages are a relative price. The fact that aggregate demand falls (or, if you’re a monetarist, that there is excess demand for means of payment) tells us nothing about whether *relative* prices are out of line, and if so in which direction.
In a recession, there is unemployment of labor. Does this mean that wages are too high? But there is also excess capacity in the capital stock. By the same logic, this means that profits are too high. And, there is increased vacancies in residential and commercial real estate. So by the same logic, rents are too high. In a recession, *all* factors of production are underutilized, but it is logically impossible for the relative price of all factors of production to be too high.
if you observe *technological* unemployment, i.e. unemployment resulting from a shift to more capital-intensive forms of production, *then* you can say that real wages are, in some sense, too high. but that is not what we observe in business-cycle recessions..
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I should add that your new position is much weaker than the one in the original post (so it’s clsoer toa successful side-step.) There, you said that “a falling real wage tends to be a characteristic of any recovery” (my emphasis). Now, you’re merely saying that ceteris paribus, lower real wages would help a recovery. I think that’s wrong too, but even if it were right it wouldn’t support the claim in the original post that our *only* choices are falling real wages due to inflation, and falling real wages due to falling nominal wages.
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That’s fascinating about Rand, David. And about the John Birch Society… have you read some of the literature they put out? There is a point in Gary Will’s Birch Society opus None Dare Call It Conspiracy in which he quotes J.K. Galbraith sarcastically averring that president Nixon’s advisers surely take inspiration from Marx… and he reports this straightfacedly as evidence that Nixon is socialist! But to be fair, the Bircher case against Nixon was stronger than their contention that Eisenhower and Kennedy were in on the international communist conspiracy.
Of course, it’s important to remember that we’re interested in economics because of what it can tell us about the present situation, and not get bogged down in the soap opera of the history of economics. But the soap opera is pretty entertaining.
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Will, Were you trying a little self-promotion there? None Dare call it conspiracy was written by Gary Allen, not Gary Will. First I thought you meant Gary Wills, a right-winger in his youth, who became a bit of a leftist in later life, but he was never a Bircher. Anyway, Mises has become such a cult figure that there is some value in pointing out that he had his share of faults just like ordinary mortals.
JW, It’s complicated. And I admit that I was trying to make a polemical point about falling real wages that was not fully worked out. The problem, I think you will agree, is that most propositions about the effects of changes in one variable on another in economics are derived from comparative statics exercises, which compare equilibria before and after an exogenous change in the relevant variable with all other variables held constant. That method breaks down in a depression when too much stuff is going on and the initial position is too far removed from equilibrium to make any meaningful comparison between equilibria. So then the question becomes if raising the price level in a depression reduces the real wage, is it possible to construct a scenario in which a) the real wage would not fall without the increase in the price level and b) employment would be greater with lower price level than the higher price level. Would you like to take a crack at that one?
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Whoops! This is what happens when we don’t have proofreaders. I meant Gary Allen; Wills is a serious writer! Thanks for pointing out the error. Interestingly, Mike Allen who runs Politico is the son of Gary Allen.
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“In the boom period that ended in 1929 labor unions succeeded in almost all countries in enforcing wage rates higher than those which the market, if manipulated only by migration barriers, would have determined. ”
I not overly familiar with the situation in the USA during the 20’s, but IIRC, unions were not very powerful. It took the Great Depression and government intervention to make them powerful. And in the UK at least the 20’s were marked by persistent high interest and unemployment rates, demanded by the City.
Is there any place in Europe where Von Mises’ statement was actually true?
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I don’t see there is a necessarily a contradiction with what Mises said. He said that real wage rates (not simply real wages) had to fall. A decrease in wage rates by increasing the demand for labor could conceivable lead to an increase in real wages.
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Barry, I agree that unions were not that strong in the US until passage of the NIRA and the Wagner Act. Mises would probably have argued that unions were still able to control entry and raise wages in some trades. Unions were I think stronger in the UK and other European countries in the 1920s than in the US, but I can’t really site any facts to support that impression.
Justin, You mean by increasing the amount of labor demanded not the demand, you are talking about a movement along the demand curve not a shift in the demand. You are trying to distinguish between real earnings by labor (hours worked times the real hourly wage) versus the real hourly wage. If hours worked increase by more than the reduction in the hourly wage total real earnings by labor would increase even though the real hourly wage fell.
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