Ron Paul’s Money Illusion (Sequel)
Wed, 23 Mar 2011 15:11:00 GMT
As I promised to do here, I am posting a sequel to my original column: Ron Paul’s Money Illusion. I want to thank everyone who took the time to comment and criticize the views expressed there because it has led to me to sharpen my thinking on the matter. I doubt that what I have to say here will sway opinion one way or the other, but I at least hope that the nature of my criticism will be more
To put things another way, people eat bread, not money. The nominal price of bread, in of itself, is an uninformative measure. What would be informative is its nominal price in relation to one’s nominal income (or wealth). The first graph above has nothing to say about how nominal incomes have evolved.
Let me now combine the two graphs above into one picture, with both series inverted, and with both the price-level and nominal wage rate normalized to $1.00 in 1948 (the actual nominal wage rate was $1.43).
According to this (publicly available) data, the price-level (CPI) has increased by about a factor of 10 since 1948. But the average nominal wage rate has increased by a factor of 25. (There is, of course, considerable disparity in wage rates across members of the population. But I am aware of no study that attributes significant wage or income heterogeneity to monetary policy. Of course, if readers know of any such studies, I would be grateful to have them sent to me.)
The figure above implies that the real wage (the nominal wage divided by the price-level) has increased by a factor of 2.5 since 1948. This is undoubtedly a good thing because it implies that labor (the factor we are all endowed with) can produce/purchase more goods and services. More output means an increase in our material living standards (Though again, I emphasize that this additional output is not shared equally. But surely a laissez-faire world advocated by some is not one that would generate income equality either.)
Now, an interesting question to ask is how the picture above might have been altered if the price-level had instead remained more or less constant. Judging by the emails I receive, many people evidently believe that the nominal wage path depicted above would have largely remained the same (that is, they apparently seen no connection between nominal wages and the price-level).
If this was indeed true, then the average real wage in America would have increased by a factor of 25, instead of 2.5 under a regime of price-level stability. And if you believe this, or something close to it, then the conclusion would indeed be startling: the inflation generated by the Fed has apparently served only to reduce the purchasing power of labor (diverting resources to powerful capitalists). This claim–or some variation of it–is implicit in the quoted passage above.
I suggested, in my original post, that there is reason to believe that under an hypothetical regime of price-level stability, the nominal wage rate in the graph above would instead have ended up increasing only by a factor of 2.5 (more or less)–the factor by which real wages actually rose. This is what I meant by my claim of long-run neutrality of the price-level increase; and it is also what I meant by Ron Paul’s Money Illusion (which is subtly different than claiming the superneutrality of money expansion; more on this later).
Some evidence in favor of my "long-run neutrality view" is to be found in the time-path of labor’s share of income (GDP):