Many economists who subscribe to some version of the Phillips Curve have been puzzled by the tepid nominal wage growth in recent years, even though the official unemployment rate has collapsed and we should be in “overheating” territory at this point. (This same, falsified framework led Krugman back in 2010 to warn of impending price deflation—ending with “Japan, here we come”—though curiously, he hasn’t since apologized for using a model that gave the wrong predictions about price movements in the wake of the financial crisis.) In this context, Scott Sumner offers a much more straightforward explanation, based on his Market Monetarist framework, that attributes nominal wage growth to Fed policy, rather than any “micro” considerations. Yet as I’ll demonstrate, Sumner’s breezy explanation is seductively simple, and smuggles in a lot of his theoretical assumptions in the guise of macro tautologies.
I readily concede that if we independently thought that Sumner’s framework were the best way to think about the Fed policy, then its ability to effortlessly “solve” the unemployment/wage puzzle would be gravy. Yet as I have pointed out earlier, Sumner’s whole framework relies on a definitional trick.
According to Sumner’s framework, the Fed foolishly tightened monetary policy in the recession period (denoted by the middle gray bar). We “know” this because the blue line not only stopped growing, but actually fell for a bit. Sumner would describe this as Fed tightening, even though the Fed funds interest rate fell to virtually zero percent, and even though the Fed more than doubled its balance sheet in a few months’ time (the sharp spike in the red line).
Finally, let me point out that if Sumner were correct, then the contrast between his approach and that of (say) Krugman doesn’t really have anything to do with macro versus micro, as Sumner seems to believe. I could just as well “explain” the wages of a particular individual using Sumner’s framework, too.
Obviously Jimmy’s flippant response is not as ludicrous as Scott Sumner’s explanation of sluggish wage growth, but if you can spot the problems with Jimmy’s response, then you can see the analogous shortcomings in Sumner’s.