Here is a graph I have shown before. This has been hidden by low levels of inflation and the broad tendency to view wages as a moral indicator, with higher always being better. But, in this recession, wages have been very high, considering the level of unemployment we have had. Since 1967, there has never been a sustained deviation from the trend like this. This is problematic because unemployment in a recession is, in part, a product of inflexible nominal wages. Employment would recover more quickly if wages were more flexible, which we normally alleviate through moderate inflation, which allows real wages to moderate without causing nominal wages to moderate as much. So, some of this may be a product of tight monetary policy, which has allowed inflation to remain very low.
Here is a long-term comparison of measured Average Wages, compared to the average wage we would have had if real wage growth did have a perfectly linear relationship to the unemployment rate (the trendline above). The trend here is based on the linear regression from 1967-1999, so real wages stayed very near the trend for 9 years out of sample. Over time, actual wages moved along with expected wages with very little deviation, until the fall of 2008. Then, actual wages deviated significantly from predicted wages, and have remained high throughout the recession.
These graphs might help to highlight some of the potential tradeoffs of this policy. Of course, we would hope that monetary policy would allow the economy to proceed without having to make these nominal adjustments. But given the monetary policy we have, it seems to be adding insult to injury to create policies that explicitly create wage rigidity.
I'm not talking simply about there being a problem of potential workers not lowering their reservation wage enough to become reemployed. I am sure that this effect is there. But, as we can see in persistence, both of high relative wages and of unemployment, there has been a lingering problem of market disequilibria. The larger problem here is the destruction of information. The wage levels employers are seeing don't reflect the long term equilibrium price of labor. Labor costs are interwoven with all the other inputs of production, so that this temporary disequilibrium not only prevents able workers from quickly reintegrating into the productive economy, it distorts and seizes up decision making across the economy through the destruction of information. This is an informational and coordination problem.
This seems like an important problem for economists to discuss, but, at least out here in the blogosphere, we've got left-wing economists who would find it difficult to accept a framing that has a possible conclusion that wages are too high, and right-wing economists who would question a framing that says the central bank is too tight. Because of these constraints, the topic seems generally ignored.
When employers say that labor markets are tight, it seems like they are being dense or hypocritical. But, could they simply be recognizing at some level that wages are too high relative to other inputs? Maybe their heuristics are functionally correct to lead them to be wary of raising wages further in order to expand production.
I don't think this is a magic formula where real wages have to fall back to the long term trend line. But, I do wonder if we might see a period where real GDP and inflation are both healthy, but wages retrench a little bit while unemployment continues to fall. The Economist (via Scott Sumner at econlog) points out that this is the current pattern in Japan.
The downside there is probably the danger of populist policies in an election year, to solve the "problem" of wages not keeping pace with economic growth.
It is strange to me how difficult it is for us to imagine that, on the margin, some workers might have discretion about the duration of their unemployment. Here is an article on the effect of homeownership on unemployment duration. (HT: EV) They find that homeowners with mortgages have unemployment behavior more similar to non-homeowners. The extended duration and the tendency to exit the labor force come from homeowners with high equity ownership. Yet, oddly, they seem to stick with the explanation that homeowners are less mobile and are tied to limited labor markets.
To me, this finding obviously comes from the fact that high equity home owners have more savings, more discretion, and more flexibility about how to re-enter employment or about making work-leisure trade offs. I don't see any mention of this obvious factor in the paper. We all know people who have discretion in their labor force decisions. Why do they disappear when we start thinking about the big picture?
This seems like further evidence that the longer UI is extended, the more it will go to workers with discretion, and that the levels of long term unemployed and wages have been distorted in novel ways, made worse by tight monetary policy. In the end, if the recovery was permanently slowed and there is hysteresis in gross production and in employment, I am not sure what the adjustments will be. Where will average wages be in a healthy economy that has moved beyond these distortions?
Here is a post from Dean Baker at CEPR (HT: EV) He points out that the Retail and Leisure & Hospitality sectors have both shown double digit increases in job openings with stagnant or declining hiring. This could be a signal of frictions in the low wage spectrum that we might expect to see when there is policy-based wage rigidity. Further recovery in production and employment might coincide with a normalization of hiring in these sectors, along with a relative moderation in wage levels. CEPR is also a good window into the sources of the subsequent populist policy responses.