Krugman was discussing analysis Mark Thoma was doing about a San Francisco Fed paper on wages. The question being asked is: why are wages so strong? Why is wage growth so strong?
In a way this is a strange question is it not? Or at least one can't help but notice that wage growth is generating perplexity-and not a happy kind. Implicit in the question is that this is not a happy situation. But shouldn't it be?
I mean if US wage growth is up, then don't we as Americans stand to gain from this? Well, this really depends. And this also points to why so many times many things that would help us tend to be politically problematic.
A major change that came with the rise of Keynesianism is the recognition that wages are sticky and so during depressions-with "liquidity traps"-the market can't clear to a lower level of equilibrium. Keynes showed that the economy can't be expected to come back via wage cuts.
Keynes also argued that workers are right to resist cuts to their nominal wages much more vigorously than real wage cuts via rising inflation. What happens in a recession is that employers seldom cut wages of current employees. They even continue to give their best employees moderate wages, while the rest remain the same. This is why wages are sticky as Mark Thomas tells us:
"Researchers generally point to asymmetries in the distribution of observed wage changes among individual workers as evidence of nominal wage rigidities. Figure 2 plots an example of this type of wage change distribution in 2011. The dashed black line shows a symmetric normal distribution. The blue bars plot the actual distribution of nominal wages."
"The figure’s most striking feature is the blue bar that spikes at zero, indicating the large number of workers who report no change in wages over a year. This spike stands out in the distribution of actual wage changes, suggesting that, rather than cutting pay, employers simply kept wages fixed over the year. This is supported by the large gap to the left of zero between the actual distribution of wage changes and the dashed black line representing the normal distribution. This gap suggests that the spike at zero is made up mostly of workers whose wages otherwise would have been cut."
In this recession, wages have been more sticky than usual even. Why is this? As the San Francisco Fed tells us:
"Real wage growth, that is, wage growth after accounting for inflation, has held up surprisingly well in the recent recession and recovery. Despite modest economic growth and persistently high unemployment, real wage growth has averaged 1.1% since 2008. As Figure 1 shows, this pattern contrasts notably with previous decades, when real wage growth slowed substantially in response to business cycle downturns. "
"One reason real wage growth has been so solid is that inflation has been low, with the personal consumption expenditures price index increasing at an average annual rate of 1.8% since the start of 2008. Low inflation means that employers cannot reduce real wages simply by letting inflation erode the value of worker pay. Instead, if they want to reduce real labor costs, they must cut the actual dollar value of wages. Employers generally avoid doing so because cuts to nominal wages can reduce morale and prompt resistance even in difficult economic times (Kahneman, Knetsch, and Thaler 1986)."
"The inability or unwillingness of employers to reduce nominal pay is known as downward wage rigidity. When economic conditions are poor, this rigidity can disrupt normal labor market functioning, especially in a low-inflation environment. If wages are downwardly rigid, workers may receive false signals about the value of remaining in a particular occupation or industry. For example, consider construction workers who are less productive now than they were five years ago because of the bursting of the housing bubble. If their wages fell, they might seek jobs in other industries. Because of downward wage rigidity, they may stay in construction instead. On the labor demand side, employers that can’t cut wages may delay expanding payrolls as conditions improve. Either way, downward nominal wage rigidities can result in misallocation of resources in the economy."
But this is why inflation can be politically divisive too, why the Fed or for that matter the President may be reluctant to say "We want more inflation." Remember that even though unemployment is high, most Americans are employed. Even when it was at 10.1% that meant most Americans were working. One reason why inflation is a good tool to fight recessions is that you can cut workers wages and get around the "stickiness."
However, it's easy for GOP politicians to demagogue this and say that this is to the dis-benefit for workers for the benefit of the "lazy" unemployed. Of course another benefit is that inflation reduces the real amount of debts we owe-so of course the creditors aren't enamoured of inflation either.
While I don't think it will work, in fact I haven't heard much about it lately, the GOP at one point was hammering away at high gas prices. While it's a total red herring policy wise-there is nothing President Obama can do short term about this(most of the long term things the GOP wouldn't want like building up alternative energy and higher fuel efficiency which Obama has already done)-it makes some political sense.
That correlation is not one and the same with causation would never occur to them. So it is with inflation and why the politically motivated attacks on it can prove quite effective.
Finally Krugman makes the point of just how brutal the policy choice that Germany and the EU would oppose on Greece-remember Greece and much of the periphery is truly in a depression at this point:
"The stickiness of wages even in the United States — which has one of the most “flexible”, aka brutal, labor markets in the advanced world, makes it clear just how huge the costs of the eurozone strategy of “internal devaluation” — getting wages down in peripheral economies, until competitiveness is regained — really is. By asking that Ireland, Spain, Portugal achieve double-digit falls in nominal wages, the Germans and the ECB are actually demanding something that basically never happens."
Nice touch-the way he points out that while the phrase, "flexible labor markets" sounds very nice and salutary, it's quite a brutal thing that is had in mind