I have been writing about the Effective Demand rule for monetary policy lately. The version that I have been showing uses a labor share anchor, which is a projection of where labor share will be at the natural limit of the business cycle. Labor share has always tended toward its labor share anchor at the end of a business cycle. So the labor share anchor is a measure of the eventual potential in the economy.
Some people may not feel comfortable with the anchor as it is estimated from a trend line of effective labor share. I have another version of the Effective Demand Rule that uses the labor share data that is released by the US Department of Labor: BLS… without converting it to an anchor.
Comparing Graphs of Each Version.
First graph uses the anchor representing the eventual natural potential. Second graph uses the trending effective labor share. (Effective labor share = Non-farm labor share: Business sector * 0.762) The second graph is a more straight-forward way to measure the base nominal interest rate for an economy. They both can be produced on a monthly basis using monthly data for capacity utilization, unemployment and inflation.
Since the crisis there is little difference between the two graphs. Yet you will notice some differences. For example, between 1998 and 2004, monetary policy is seen as tighter before and after the 2001 recession. The economy was building slack after 1998 and a lower Fed rate would have been proper. The version above using trending labor share shows that better. Labor share ultimately fell (after 2001 and especially after the crisis) and ate up some of that accumulating slack.
Comment on Secular Stagnation
What some call secular stagnation is the process of labor share falling to eat up excess slack caused by competitively lower labor shares overseas, lower overhead costs overseas and new productive technology. But in actuality, the excess slack no longer exists while labor share stays low. If you do not understand this, you will still see the slack, like Krugman, Summers, the Fed and others.
Should the fall in labor share have been temporary? Did it become an undesired global downward spiral? I think so… If advanced countries could now coordinate a reversal of falling labor share, the aura of secular stagnation would dissipate like a morning fog.
Note on Accuracy of Effective Demand Monetary Rule
Note: An important thing to realize in the Effective Demand Rule equation is that the only value of labor share that works… is the basic “effective” labor share value used to determine Effective Demand. Thus the accuracy of the Effective Demand Rule (when compared to the actual Fed rate) supports the calculation of the effective labor share, and thus the projection of the Effective Demand limit.