Notes on Money-Income Causality and Sticky Wages

The initial impetus for this post came from David Henderson's helpful encyclopedia entry for Christopher Sims. I found the money-income causality argument particularly interesting:

One of Sim's earliest famous contributions was his work on money-income causality, which was cited by the Nobel committee. Money and income move together, but which causes which? Milton Friedman argued that changes in the money supply caused changes in income, noting that the supply of money often rises before income rises. Keynesians such as James Tobin argued that changes in income caused changes in the amount of money. Money seems to move first, but causality, said Tobin and others, goes the other way: people hold more money when they expect income to rise in the future. 

Which view makes more sense? Upon applying Clive Granger's econometric test of causality, Sims concluded:

The hypothesis that causality is unidirectional from money to income [Friedman's view] agrees with the postwar U.S. data, whereas the hypothesis that causality is unidirectional from income to money [Tobin's view] is rejected.

Regular readers won't be surprised, that I also consider money-income causality effects in terms of tradable sector and non tradable sector contributions to general equilibrium outcome. Even as causality mostly originates via money to income, additional money supply (non inflationary) still originates in positive output changes. As always, real economy growth - or the lack of it - is the long run deciding factor.

While output growth is relatively transparent in tradable sectors, the lack of actual output transparency in (some forms of) non tradable sector activity, makes for too easy assumptions that causality may flow from income to money. Importantly, the income to money causality rationale can prove dangerous as well if carried too far. However, today's knowledge production dependency, which I've referred to as a form of secondary market, is so integral to economic activity that oft extensive price making in these areas isn't easy to discern. Price making in non tradable sector knowledge production can be all the more problematic, since it further impacts supply and demand for all markets in unpredictable ways.

Even though non tradable sector time based product depends on general equilibrium dimensions, once a nation's high skill professionals gain confidence in their country's resource capacity and market definition, wage or income demand becomes resistant to change, hence is "sticky downwards". Chances are, downward stickiness also provides rationale for the appearance of income to money causality, because a nation state will take extensive monetary and fiscal measures to maintain a given general equilibrium level, especially after general equilibrium conditions begin to suffer from too few ares of growth (wealth) origination.

Wage stickiness in tradable sector activity is generally less of a problem. These points of wealth origination are often quick to respond to changes in supply and demand, in that output levels which directly contribute (internally) to nominal income aggregates, can be readily shifted. On the other hand, professional time based product in non tradable sector activity, where compensation is externally derived from existing monetary flows, lacks the flexibility to quickly respond to market changes. Hence the activity of the latter imposes restraints on general equilibrium conditions which may not be easy to recognize. In a recent follow up of an earlier popular post re sticky wages, David Glasner observes:

Market-clearing equilibrium requires not merely isolated price and wage cuts by individual suppliers of inputs and final outputs that will be consistent with market clearing, but a convergence of expectations about the prices of inputs and outputs. And there is no market mechanism that achieves that convergence of expectations.

Consider why this matters, for what have become the required societal inputs which ultimately result in a "final" form of high skill time based product. Presently, the costs of human capital - due to societal expectations - are resistant to the recent ability of digital potential to contribute to learning by doing processes which could greatly reduce these initial cost burdens. Nevertheless, not only does the asymmetric compensation of secondary market knowledge application provide immense skills flexibility, it is integral to the very framework in which much of today's wealth takes place. Sticky markets indeed!

Hence what is now needed, is a digitally enhanced supply side structure for knowledge production, which can generate new wealth capacity to restore a growth frontier along the margins of today's NIMBY general equilibrium. A symmetrically aligned organizational structure creates internal reciprocity, which in turn makes internal coordination a viable economic option. After all, as Glasner rightly explained, it can be all but impossible to achieve the coordination of labour markets at a general equilibrium level. Fortunately, it's still feasible to create defined equilibrium settings at local levels, where the time value of our labour might once again contribute to overall growth and productivity.