The Cult of “Price Stability” Is Killing American Workers

Paul Krugman mused over the weekend about the declining labor share of national income and ended up doing a column on it. It’s worth reading the blog posts, though, because they’re wonkier and deeper in the weeds. The two theories are that it’s “capital-biased technological change,” which doesn’t seem to fit the data about investment levels, or that some kind of mysterious monopolization effect is taking place. You should read Phillip Longman and Barry Lynn’s article about this if you’re interested, but I don’t think their story remotely matches the observed behavior of relative prices. If you compare 2012 to 1972, basically everything that you could go buy at a store is much cheaper despite alleged increases in market concentration. In fact, that stuff is all cheaper in part because of the rise of giant, hyperefficient, global firms.

I have what I dare say is a more Krugmanian story to offer. The declining labor share of national income isn’t the result of mysterious technological forces; it’s the result of policy choices, specifically macroeconomic stabilization policies. Specifically the idea that the thing that macroeconomic policy ought to stabilize isn’t output or employment but inflation—which is to say wages.

You often hear members of the central banking establishment allude to the “hard won” battle against inflation in the early 1980s. But the battle was in fact won very quickly and decisively. And not coincidentally, since the victory the labor share has tended to steadily decline as seen above.

My first introduction to the mysteries of monetary policy came when I was maybe 15 or 16 in the mid-to-late ‘90s and I was scanning the newspaper over breakfast. I saw a story about a strong Employment Situation Report from the Bureau of Labor Statistics and how it sent the stock market falling in response because markets were anticipating a rise in interest rates. Why, I asked my dad, would an increase in employment be bad? He explained that when too few people were unemployed, the Federal Reserve tended to get worried because with so few unemployed people around, workers would start agitating for higher pay. And higher pay leads to inflation. So it’s important for the Fed to respond to low unemployment with high interest rates to push unemployment higher and prevent wage gains. This sometimes has the incidental impact of causing stock prices to fall because it makes bonds more attractive.

That sounded insane to me, and my dad agreed that it was insane and explained that, as Marx wrote, executive of the modern state is but a committee for managing the common affairs of the whole bourgeoisie.

To put it nonpolemically, you can see in the chart that not only is there a structural trend in the labor share of output, there’s also a strong cyclical trend. The labor share declines during recessions and rises during booms. And the problem of the Federal Reserve is that over the past 30 years, it has a perfect track record of never allowing inflation (which is to say a sustained period in which wages rise faster than productivity), but it doesn’t have a perfect track record of never allowing recessions. The inevitable consequence of this asymmetrical success is for the labor share to steadily decline.

Now don’t get me wrong. The moral of the story isn’t that inflation per se is a good thing. But if you watch Kevin Durant play a whole season of basketball and his free throws never miss to the right, that’s not a sign of shooting skill. It’s a sign of shooting error. Some misses are inevitable, but you want the misses to be roughly symmetrical because you’re aiming for the hoop. If all your free-throw misses are misses to the left, something’s going wrong. A Fed that sometimes allows for recessions and prolonged periods of high unemployment but never allows for inflation is creating a situation in which the wage share of the economy must fall over time.