What Would The Federal Reserve Do If Retail Wages Surged?

Moneybox
A blog about business and economics.
Nov. 19 2012 1:44 PM

What Would The Federal Reserve Do If Retail Wages Surged?

Catherine Ruetschlin has produced an outside-the-box policy brief for Demos arguing for "a new wage floor for the lowest-paid retail workers equivalent to $25,000 per year for a full-time, year-round retail worker at the nation’s largest retail companies—those employing at least 1,000 workers."

Conventional thinking would say this would result in massive job losses, but she argues that we should actually see it as a form of fiscal stimulus:

The economy would grow and 100,000 or more new jobs would be created. Families living in or near poverty spend close to 100 percent of their income just to meet their basic needs, so when they receive an extra dollar in pay, they spend it on goods or services that were out of reach before. This ongoing unmet need makes low-income households more likely to spend new earnings immediately – channeling any addition to their income right back into the economy, creating growth and jobs. This “multiplier effect” means that a higher wage standard for retail workers will also generate new jobs. Our estimates of the job creation effect are derived from widely accepted multipliers on consumer spending. It includes the benefits of a raise on disposable income and accounts for the impact of any additional costs to the firm and the potential for businesses to pass-through the cost of decent wages onto their customers through higher prices.
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You can model the impact of the higher wages on profits and consumer prices in different ways, but she concludes that if firms engaged in 100 percent consumer pass-through of the costs it would amount to a one percent increase in retail prices.

This is where I get interested in the monetary policy tie-in. In a classical framework, Ruetschlin is offering a prescription for massive job losses. The key argument here is that the classic framework is inappropriate given the large existing outgap gap. Her view is that under the circumstances, you'd see both higher real output and an increase in the price level and that the benefits in terms of real output far outweigh the costs. This is precisely the calculus made by advocates of monetary stimulus (myself included)—given the large output gap, a little more relaxation on inflation targeting could create a lot of additional real output. Alternatively, the same thing could be achieved through adopting a nominal GDP target. And within any monetary policy framework, it's possible that you would need some kind of fiscal or other "kick" to deliver the goods more rapidly. That's essentially what Ruitschlin is pushing for here.

But then another question you might ask is what would be the impact on the economy of this policy switch in the context of continued strict two percent inflation targeting? Well, the higher consumer prices would militate in favor of tighter money. And the higher wages would also militate in favor of tighter money. So any possible benefits would likely be wiped out.

The moral of the story, in short, is that whatever it is you care about in economic policy you have to care about monetary policy, because anything with a big impact on the national economy is going to have a measurable impact on the price level. How does the Fed react is a key question.

Matthew Yglesias is the executive editor of Vox and author of The Rent Is Too Damn High.

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