Judy Shelton On Downward Nominal Wage Rigidity

From the Independent Institute, “The Moment Janet Yellen Moved for ‘Greasing the Wheels’ with Inflation”, discussing a 1996 meeting of the Fed:

Ms. Yellen proceeds to make the scholarly case for 2 % inflation as the preferred target based on what she describes as a “greasing-the-wheels” argument. Citing an academic paper co-authored by her husband, well-known economist George Akerlof, Ms. Yellen suggests that “a little inflation lowers unemployment by facilitating adjustments in relative pay in a world where individuals deeply dislike nominal pay cuts.”

The theory assumes that workers resist, and firms are unwilling to impose, nominal pay cuts even when firms are experiencing losses—an assertion that aligns with Keynesian notions about “sticky wages” despite an economic downturn.

Two observations:

  • George Akerlof is a well-known economist. He is also a Nobel laureate in economics.
  • Shelton writes as if downward nominal wage rigidity is a “theory”, essentially ridiculing the idea. In reality, it’s an observation, validated by overwhelming amounts of evidence in the US and other advanced economies.

On this second observation, a very large empirical literature has documented downward wage rigidity, mostly based on survey data. The latest research — using administrative rather than survey data — still indicates a lot of downward rigidity on hourly compensation (less so on total compensation); from Grigsby et al. (AER, 2021) [ungated version]

(Click on image to enlarge)

Source: Grigsby, Hurst, Yildermaz (2021), ungated 2020 version.

Finally, while Dr. Shelton disparages the 2% inflation rate (on the Personal Consumption Expenditure deflator, not the CPI) as not “price stability”, 2% might not be too far off. That’s because there’s probably some upward bias to any government price index because of the failure to capture quality changes and the introduction of new products. For the CPI, one estimate cited is 0.3 to 1.4 percentage points bias (see discussion in Goshen et al. (JEP, 2017).

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