I was reading PGL’s post about Mankiw’s latest whatever-it-is-one-calls-that-thing-that-Mankiw-does, and I had a thought. I’m kind of sick right now, so I don’t know if the thought only makes sense to me because I’m sick, or if there’s something to it.
So… fully prepared to be very embarrassed when my mind is back at work, here’s my thought….
Two of the basic inputs into production are capital and labor. There is a price floor on labor – its the minimum wage. But there is also a price floor on capital – its the fed funds rate. Just as few workers work at the minimum wage, most capital gets paid more than the fed funds rate, or at least the “real” fed funds rate, which would be the fed funds rate less the rate of inflation.
One difference between the minimum wage and the fed funds rate is that while the latter is sometimes raised, it is also sometimes lowered. Except that it isn’t a real difference… the real minimum wage, adjusted for inflation, is also lowered sometimes… in fact, it is usually being decreased. Simply keeping the minimum wage constant, as it has been kept for years now, lowers the real minimum wage.
Now, raising the cost of capital can decrease the amount of capital that gets used, slowing down the economy. (It doesn’t always… sometimes even raising the price floor doesn’t bring it to the market clearing level.) Lowering the cost of capital can increase the amount of capital that gets used (again, with the caveat above the market clearing price), which can overheat the economy.
So what are the differences between the real Fed Funds rate and the real minimum wage? From what I can tell, they are these:
1. The nominal wage is sticky downward, so decreases in the real minimum wage are bounded by the rate of inflation. The real Fed Funds rate can be decreased more quickly.
2. The folks who have political power in this country control capital, not labor. Capital is more valuable, regardless of the cost of capital itself, when labor is cheap.
3. I imagine Mankiw would have a conniption if anyone ever advocated a slow constant deterioration in the real fed funds rate.
Anyway, that’s about all the brain is producing right now. So tell me what’s wrong with what I just wrote.
Update. Corrected typo pointed out by Laurent GUERBY.