Thread by @jasonfurman

Nominal wage growth definitely leads to price growth. And price growth definitely leads to nominal wage growth.

The open questions are:
1. How rapid is the transmission in each direction

2. Is the transmission more or less than one-for-one

3. Which goes up more

A 🧵.

On the *definitely* point if nominal wages and prices each followed their own totally unrelated dynamics you would see some very strange changes over time.

We don't and countries with 5% inflation have faster nominal wage growth than countries with 1% inflation. Etc.

In the short run the same forces are at work for both. Higher demand gives businesses more purchasing power so higher prices. And it gives workers more bargaining power so higher nominal wages.

Moreover there is a direct link at the level of a business. If you're business raises its prices then it will generate more profit per employee and want to hire more of them (a shift of the labor demand curve). To get them it will need to raise wages.

https://twitter.com/jasonfurman/status/1493411130538184709?s=20&t=JVdLncvNXLkNXL6UuiN4ig

Going the other way, businesses raise prices when input costs rise. Like gas stations and the price of oil. The main cost for most businesses is labor, why would you think that increases in that cost would not go into prices?

So that brings us to the three open questions.

1. The speed of the transmission in both directions may have gone down in recent decades. That may be related to more anchored inflation expectations or fewer unionized indexed contracts. I'm not sure.

2. If the transmission is more than one-for-one you can get an upward spiral of 6% wage growth → 5% price growth → 7% wage growth → 6% price growth etc.

I view that as implausible and to the degree this is what a "wage price spiral" means I'm also dismissive.

3. Which goes up more is the question of whether the real wage is proycliycal (tighter labor markets raise wages more than prices) or countercyclical (tighter labor markets raise prices more than wages).

This is the one I'm least sure of.

Keynes himself and traditional Keynesian economics emphasized a countercyclical real wage. In booms you hit increasingly diminishing returns to labor and wages fall. Plus wages are adjusted less frequently than prices so faster inflation means lower real wages.

This argument could be supplemented in an institutional/bargaining context by noting that inflation is a reduction in the real value of the federal minimum wage which is another reason to expect that faster price inflation would lower real wages, especially at the bottom.

Arguments about corporate profiteering & inflation also seem to be consistent with this view. Essentially those arguments are that firms are passing along cost increases more than one-for-one. Or that demand raises firm's pricing power more than worker power so lowers real wages.

On the other side is the New Keynesian assumption/result that the markup of prices over costs is countercyclical. Given that the big cost is labor that is basically the same as saying the real wage is pro cyclical.

What is the evidence? Over the last twenty years the tight labor markets raise real wages has been true in the US. The open question is how much of that is because demand raises real wages vs. the late 1990s being a positive productivity supply shock.

Over a longer period and more countries there is not much relationship between unemployment or other measures of tightness/business cycle and real wages. Maybe real wage are mildly procyclical. But maybe they are not and they fall in booms.

More careful recent research on the markup by Chris Nekarda and Valerie Ramey has contradicted the New Keynesian finding on the cyclical markup and suggests maybe tighter labor markets lower real wages. onlinelibrary.wiley.com/doi/abs/10.111…

So I'm torn on the question of whether a hot economy raises prices or wages more. But I'm sure a hot economy helps employment and that is a more than sufficient argument for it (provided it not overheated and thus unsustainable).

In conclusion, institutional changes like the decline of labor unions/COLA contracts may shift the timing and magnitude of the wage-price passthrough. But even without them the underlying economic forces of supply and demand will still create a tight link, at least over time.