Monday, September 24, 2007

Shorter Case for Labor Cost Targeting

Look, there’s a good chance the s___ is going to hit the fan in the next few years, if not in the next few weeks**, with a crash in the dollar and a takeoff by commodity prices, especially oil. The Fed has 3 choices:
  1. It can wait for the s___ to hit the fan and then do nothing.* Bond markets, product markets, and labor markets will lose confidence in the Fed’s resolve for price stability, and the result will be stagflation (a concept with which readers my age and older will be familiar from experience, but younger readers may have to use their imaginations).

  2. It can wait for the s___ to hit the fan and then tighten aggressively. The result will be a major recession.

  3. It can “announce” as soon as possible that it intends to target labor costs, and when the s___ hits the fan, do nothing.* The result, with any luck, will be a couple of years of high inflation rates, with normal economic growth, followed by more normal economic growth along with low inflation rates.
I’m just saying, choose what’s behind door number 3. It doesn't really matter if you're a capitalist or a worker or a rentier or a financial technocrat or what. It's just the best choice.

*That is, nothing except for a mild tightening to offset the economic stimulus from the weaker dollar.

**UPDATE: Let's say quite possibly in the next few weeks, if not in the next few days. The following item appears in my email this morning:
Venezuela’s state-run oil company has demanded payment for all future sales of crude and products to be in euros rather than US dollars, according to a letter to customers on September 21.

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Blogger Gabriel M said...

Maybe you should do a post on what's the nature of this s___ and how it came about.

The labor unit cost proposal is one thing, the phenomenon it's supposed to fix is another. Your readers what to know more about the problem :-)

Mon Sep 24, 09:40:00 AM EDT  
Blogger knzn said...

Maybe I will. Of course, the unit labor cost proposal is supposed to be more generally valuable than a fix for the immediate problem (since it's easy to imagine a similar problem happening in the future) but there is a certain urgency about it that wouldn't otherwise be present.

Then again, there is also the possibility of the opposite type of situation in the future -- a favorable supply shock, that is. My argument would be in a "morally" stronger position if such a favorable shock were imminent today, and I could say that the Fed should target unit labor costs and stay relatively tight in order to build credibility for the prospect of some future unfavorable shock. That case would have argued for Greenspan being tighter in the late 90s, when we had very low oil prices and a strong dollar. In retrospect, that might have been a good idea even for its short-run effects.

Mon Sep 24, 10:27:00 AM EDT  
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