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Blurb for Janeway: Doing Capitalism in the Innovation Economy, 2nd Edition

Paul Krugman attempts to summarize the state-of-play on the slack-and-wages puzzle: Paul Krugman: Opinion | Monopsony, Rigidity, and the Wage Puzzle: "The unemployment rate... suggest[s] an economy pretty much at full employment...

...But sluggish wage growth could indicate that there’s still substantial slack in the labor market. Which is it?... A number of economists have argued that the official unemployment rate, which only counts people actively looking for work, has become an increasingly inaccurate guide to the real state of labor markets.... EPOP is indeed still significantly below its pre-crisis level. But it has been a decade since the crisis–and that’s enough time to worry about secular trends in labor force participation. In particular, there’s been a long-run trend toward fewer prime-age men working, and it’s not at all clear that we’re currently below that trend.... Quits are back up to pre-crisis levels.... Another piece of evidence is what employers say about the ease of finding workers.... All in all, I think I come down on Jason Furman’s side here–not with 100% certainty, to be sure, but this really shows most of the signatures of a full-employment economy.

But in that case, why aren’t wages surging?... There have already been some analyses suggesting that an extended period of wages constrained by downward rigidity has created a sort of backlog of pent-up wage cuts that is currently holding down wage increases.... There’s now a lot of evidence that many employers have considerable monopsony power in the labor market.... A firm that has monopsony power over labor... would normally be happy to get more workers if it could do so without paying higher wages. That is, complaints about labor and/or skill shortages are normal for many employers....

During the years of high unemployment, firms faced... workers desperate for jobs. This “should” have allowed them to cut wages – but for the most part they couldn’t, because wage cuts have lots of adverse side effects.... I’d argue that the combination of downward nominal wage rigidity and monopsony power helps explain both why wages didn’t fall during the period of high unemployment and why employers aren’t doing much to raise wages despite tight labor markets now....

The bottom line here is that I reluctantly find myself on the no slack side of this debate. I think the U.S. really is more or less at full employment. But do I think the Fed is right to be raising rates, and that we should start being worried about fiscal deficits? Actually, no.... First, I might be wrong. And the costs of tightening when the economy still has room to grow are much bigger than those of waiting and discovering that we’ve overshot a bit. Second, everything we’ve learned since a 2% inflation target became orthodoxy suggests that the target was too low.... So while I am not convinced that we have a lot of labor market slack, I actually favor policies that act as if we did...


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