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October 12, 2010

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Does a Higher Minimum Wage Reduce Jobs?

Posted: 12 Oct 2010 12:12 AM PDT

Arin Dube is interviewed about his research on the effects of the minimum wage (link to academic paper):

Here's a description of the interview:

Does Higher Minimum Wage Reduce Jobs?: ...In an interview with The Real News, Arindrajit Dube, labor economist and Assistant Professor of Economics at University of Massachusetts, said that increasing the minimum wage in some areas has not reduced jobs as expected by the conventional theory. 

Dube's research looks at the effects of minimum wage differentials across state borders where the minimum wage is higher on one side of the border than the other. His research looks at the service industry, which he said employs the majority of minimum wage workers. According to his findings, both the short and long term effects of the increased wage on unemployment were negligible. 

"And that, I think, is an important factor to keep in mind for policymakers as they consider raising the minimum wage," he said.

Dube said the conventional wisdom surrounding minimum wage comes from research done before the early '90s. ... Dube told TRNN that around the early to mid '90s some economists realized these studies were badly flawed, and began looking at local evidence instead of just national evidence. The famous work of labor economists David Card and Alan Kruger looked at the border of New Jersey and Pennsylvania when New Jersey raised its minimum wage. Within a year, he said, not only had employment in New Jersey not decreased, it had actually risen in some groups. 

He said the report received strong criticism from the economic community, but Dube's studies apply this technique across borders of all the states, over a twenty year period to track the effects in many cases, and for a much longer period. 

"In that sense, we build on, but really generalize the Card and Kruger approach, and really address some of the serious criticisms that were made. And at the end of the day our results are actually strikingly similar to the original Card and Kruger finding, even though we were able to respond to pretty much all the criticisms that were levied against the single, case study approach." 

Dube's findings indicate that a higher minimum wage helps service retailers attract and retain employees, increasing their productivity. He said that a restaurateur, for example, is likely to reduce his employees when the wage goes up if only one restaurant raises their wage, but if most of them raise it, the added cost is passed on to the consumer who is likely to absorb it without decreasing their demand. 

Dube's findings are specific to the service industry, which is generally tied to a specific market and does not have the mobility that manufacturing jobs have. However, he said there are very few Americans left in manufacturing that receive the minimum wage. ...

He said the 'spillover effect', where rising the minimum wage pushes up other wages, has only been found to affect those earning up to 25 per cent more than the minimum wage. 

Finally he added that work done by economists at the Federal Reserve showed minimum wage increase led to significant increases in purchases of durable goods. "From a perspective of stimulating demand, minimum wages will tend to increase demand by increasing the purchasing power of those workers."

links for 2010-10-11

Posted: 11 Oct 2010 11:02 PM PDT

Woodford: Bernanke Needs Inflation for QE2 to Set Sail

Posted: 11 Oct 2010 04:23 PM PDT

Michael Woodford is calling for the Fed to create the expectation of more inflation by clarifying its exit strategy and making it clear it has no immediate plans to tighten policy even if inflation rises above the target rate:

Bernanke needs inflation for QE2 to set sail, by By Michael Woodford, Commentary, Financial Times: Debate is raging within the Federal Reserve about whether to do more to stimulate the US economy. ...Ben Bernanke ... knows that a cut in rates, his usual tool, is currently infeasible. Therefore, speculation has turned to a return to quantitative easing (QE2), or large purchases of long-term Treasury bonds.
This would be a dramatic move. But we must not kid ourselves. It would have at best a modest effect in a large, liquid market such as Treasury bonds and, therefore, is unlikely to dig the US economy out of its current hole. There is, however, another option: for the Fed to clarify its "exit strategy"... This would mean making clear that the Fed has no plans to tighten policy through increases in the federal funds rate, even if inflation temporarily exceeds the rate regarded as consistent with the Fed's mandate. In short, the Fed should allow a one-time-only inflation increase, with a plan to control it once the target level of prices has been reached.
Such a move would be controversial within the Fed. But such a statement would merely be designed to help reduce expectations regarding ... the path of short-term interest rates over the next few years and to increase the expected rate of inflation. Changes in these expectations would stimulate current spending..., giving the US economy a much-needed boost.
This proposal is different from that made in some quarters (and rejected by Fed officials) for an increase in the Fed's inflation target. In order to obtain the benefits just cited, it is not necessary to make people expect a continuing high rate of inflation. Indeed, that would be counterproductive. ... Instead,... the Fed should commit to make up for current "inflation shortfalls" due to its inability to cut interest rates. ... Once the shortfall has been made up, the Fed would return to its previous, lower target.
Critics will say this will undermine the Fed's credibility on price stability. They are wrong because the price increases allowed under this "catch-up" policy would be limited in advance. ...
Others argue the opposite case: that a modest increase in prices would have too small an effect to boost the recovery. But the true value of such a commitment would be precluding a disinflationary spiral, in which expectations of disinflation without any possibility of offsetting interest-rate cuts lead to further economic contraction and hence to further declines in inflation. ...

I'm on board, though changing expectations may be harder than it seems even if the Fed clarifies it won't tighten policy until inflation spends some time above the long-run target. To be a broken record on this point, both monetary and fiscal policy are needed -- neither alone is enough -- but if I had to choose one or the other, I'd rather see the infrastructure spending Obama talked about today come to fruition rather than trying to create expected inflation.

But new fiscal policy is unlikely to happen due to considerable opposition from Republicans and a few misguided Democrats in Congress. Monetary policy is not certain either, there is resistance from some members of the Fed, but the prospects for QEII are looking good presently, and the exit strategy can be clarified, so at least there's hope. As I've said many times, I don't expect the impact of a new monetary policy initiative would be large, but it's a whole lot better than the nothing we are likely to get from fiscal policy.

"Technique is Always a Matter of Secondary Importance"

Posted: 11 Oct 2010 01:44 PM PDT

Two takes on Peter Diamond and the use of technical/mathematical economics. First, Steve Levitt:

I was delighted to see that Peter Diamond shared the Nobel Prize today with two other economists (Mortensen and Pissarides...). Diamond's intellect was legendary when I was a student at MIT. In his research, he worked on very hard problems. He wrote the kind of papers that I would have to read four or five times to get a handle on what he was doing, and even then, I couldn't understand it all.

And Glenn Loury via Ravi Sethi:

Glenn Loury on Peter Diamond, by Rajiv Sethi: Glenn Loury has kindly forwarded me a letter he wrote earlier this year in appreciation of Peter Diamond, one of the co-recipients of this year's Nobel Memorial Prize in Economics. The tribute was written for the occasion of Diamond' retirement, and seems worth publishing today:

...Peter was an inspiration and role model for me during my student years at MIT. ... I recall going over to the Dewey Library shortly after arriving in Cambridge, in the summer of 1972, and digging out Peter's doctoral dissertation. This was a mistake! Peter's reputation as a powerful theorist had been noted by my undergraduate teachers at Northwestern. I wanted to see how this reputed superstar had gotten his start. Just how good could it be, I wondered? I had no idea! What I discovered was an elegant, profound and exquisitely argued axiomatic treatment of the general problem of representing consumption preferences over an infinite time horizon, extending results obtained by his undergraduate teacher and the future Nobel Laureate, Tjallings Koopmans.

I prided myself on being a budding mathematician in those years. Yet, Peter's effortless mastery in that dissertation of the relevant techniques from topology and functional analysis, and his successful application of those methods to a problem of fundamental importance in economic theory -- all accomplished by age 23, younger than I was at the moment I held his thesis binder in my hands! – was simply stunning. This set what seem to me then, and still seems so now, to be an unapproachable standard. I was depressed for weeks thereafter!

Even more depressing was what I discovered as I got to know Peter better over the course of my first two years in the program: that mathematical technique was not even his strongest suit! An unerring sense of what constitute the foundational theoretical questions in economic science, and a rare creative gift of being able to imagine just the right formal framework in the context of which such questions can be posed and answered with generality -- this, I came to understand, is what Peter Diamond was really good at.

This is the part I want to highlight (Rajiv Sethi also points to these remarks):

And so, I learned from him in those years what turned out to be the most important lesson of my graduate educational experience -- that, in the doing of economic theory and relative to the behavioral significance of the issue under investigation, technique is always a matter of secondary importance -- neither necessary nor sufficient for the production of lasting insights. ... And so I came -- slowly and fitfully, because I was rather attached to the joys of doing mathematics for its own sake -- to see the world the way that Peter Diamond saw it. And, in the process, I became a much better economist. ...

Paul Krugman puts it this way:

And by the way, for those of us in the modeling business, Peter Diamond's work is breathtaking in its elegance — nobody cuts through the complexities with such grace.

It is really hard to convince new graduate students that mathematics without the underlying economic intuition, i.e. technique for the sake of technique, is pretty useless. It's the economics that are important -- mathematics is simply a tool that allows us to better understand the economic content of the models we work with -- the math itself is not the point of the exercise. In fact, the best models are the ones that are boiled down to the essentials so that they isolate important phenomena in a way that makes them transparent. Mathematical complexity is not always the best way to reach this goal. Models should be as complex as needed to highlight the essential issues, to use Krugman's term they should be "elegant," and additional complexity beyond that point detracts from their elegance and obscures rather than clarifies the central features of the model. Sometimes a high degree of complexity is required, but not always.

And the Winners Are

Posted: 11 Oct 2010 07:50 AM PDT

Peter Diamond, Dale Mortensen, and Christopher Pissarides:

3 Share Nobel Economics Prize for Labor Analysis: The 2010 Nobel Memorial Prize in Economic Science was awarded ... to Peter A. Diamond, Dale T. Mortensen and Christopher A. Pissarides for their work on markets where buyers and sellers have difficulty finding each other, in particular in labor markets.
For decades, the researchers have studied what happens when ... workers have different skills and weaknesses, and where all companies have different types of jobs they need to fill. In many cases, there are significant search costs to finding the ideal match between a buyer and a seller of a good, like the job to a job-seeker.
Professor Diamond, 70, an M.I.T. professor and a nominee to the Federal Reserve Board who was effectively blocked by the Senate earlier this year, first developed a broad theoretical framework for studying markets with search costs in 1971. Professors Mortensen, 71, of Northwestern University, and Pissarides, 62, of the London School of Economics, later worked with Professor Diamond to apply the theory to the labor market in particular, and how government policy could improve the matching of workers to jobs. ...
The work is considered by many researchers to be particularly timely in today's economic climate, in which many developed countries like the United States are facing stubbornly high unemployment rates. For example, the theory developed by the three economists has been used to try to design alternative unemployment benefit systems, and to determine how hiring and firing costs affect the unemployment rate.
In a telephone interview during the Nobel news conference in Sweden, Professor Pissarides said that he thought the work being honored had one lesson in particular for today's policymakers: "What we should really be doing is make sure the unemployed do not stay unemployed for too long, to try to give them direct work experience," so that they "don't lose their attachment to the labor force." ...

The last point about keeping people's "attachment to the labor force" through direct work experience is important, and policymakers haven't done nearly enough to make this happen.

Update: I have a few comments on their contributions, and quite a few links to other comments, at MoneyWatch.

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