James Medoff, my thesis advisor in graduate school and later
my collaborator and business associate, died on Saturday, September 15 after a
long struggle with multiple sclerosis.
In the field, he was probably best known for his work on labor market
institutions, and particularly for his work with Richard Freeman on the impact
of unionization. But by the time I
started working with him, most of that was in the past. I was a student of macroeconomics, not labor
economics, but I was intrigued by a paper he had written with Katharine Abraham
entitled “Unemployment, Unsatisfied
Demand for Labor, and Compensation Growth, 1956-1980.” It seemed to
provide a critical missing piece in the puzzle of macroeconomics.
Why was there stagflation (stagnation and inflation at the
same time) in the 1970’s? When I was in
graduate school, there were two popular (complementary) explanations. First, the Fed had been too easy because it
didn’t adequately account for the way inflation expectations would become
ingrained. (In the cartoon version of
this idea, the Fed goes from believing in a static downward-sloping Phillips
curve to realizing – much too late in the game – that the long-run Phillips
curve is vertical, but in reality there were certainly some steps
inbetween.) Second, there were oil
shocks, shocks to aggregate supply which drove prices up and employment
down. A third explanation you might also
hear was that the Fed had responded to political pressure from the Johnson and
Nixon (and possibly Carter) administrations and loosened at the wrong times.
Doubtless there was something to all of these ideas, but the
Medoff-Abraham paper suggested a completely different explanation. Essentially what it said was that there was
not nearly as much “stag” in the stagflation as we thought. The labor market, it suggested, had been
booming during much of the 1970’s despite the appearance of high unemployment. The implication was that the unemployment of
the 1970’s was largely “structural” (at least that’s the term used in debates
about today’s unemployment), and once you realized that, the accompanying
inflation shouldn’t surprise you.
When I took James’ graduate course in 1989, this idea was
particularly important, because the situation was beginning to reverse
itself. The plateau in structural
unemployment lasted from maybe 1975 to maybe 1987, and after that it began to
decline. By the time I graduated, in
1994, this decline was well underway, and our data were suggesting that the US
economy could support considerably lower unemployment rates without sparking
inflation. James was invited to the
Fed’s meeting of academic consultants that year to make the case for lower
unemployment, and I went along to help and observe the discussion. As I recall, there were about 10 people at
the table, and James was the only one saying that it was OK to keep interest
rates low and let the unemployment rate fall further.
Naturally, rather than listen to a single maverick, the Fed
kept raising rates, and maybe that was for the best, since the recovery turned
out to be stronger than most people (including us) had expected. But over the next few years, something
unusual happened. The unemployment rate
kept coming down, and the inflation kept not happening, and now it was Alan
Greenspan himself, not some out-of-the-mainstream labor economist from Harvard,
who was insisting (against some substantial resistance) that it was OK to keep
interest rates low and let the unemployment rate continue falling.
Did James Medoff ultimately influence monetary policy, and
was he therefore partly responsible for the boom of the late 1990’s? Who knows?
If I had Alan Greenspan’s ear, I might ask him. At his funeral, James’ daughter Susanna said
that, in fifth grade, she had wanted to dress up as her father for “Dress as
Your Hero Day,” but the teacher wouldn’t let her, so she dressed as Alan
Greenspan instead. In those days, a lot
of adults may have considered Greenspan a hero, but I doubt many other fifth
graders did. For the record, I still
think Greenspan did a remarkable job with the macroeconomic aspects of monetary
policy, and his hero status (since rescinded by most commentators) was not
without justification.
In any case, I feel that the research I mentioned is
relevant today in a couple of ways. For
one thing, the saga of structural-vs-cyclical unemployment goes on today. Using techniques similar to those used by
Abraham and Medoff, my best guess is that, after the long decline that began
around 1988, structural unemployment reached a trough in 2005 and has been
rising since then. (However, I see no
particular evidence of a discontinuous increase during the Great Recession, or
immediately before or after, and the increase since 2005 has not been
particularly rapid, so I don’t buy the view that “our problem is structural.”)
Another way the research is relevant is that it reframes the
1970’s. By the end of the 1970’s, most
economists were convinced that, as textbooks put it during my undergraduate
years and maybe still do, “the long-run Phillips curve is vertical.” In other words, there is no long-run tradeoff
between unemployment and inflation. In
the minds of most economists this conclusion was necessitated by the experience
of the 1970’s, during which it seemed to become obvious that higher inflation
was not generally associated with lower unemployment. But if much of the problem of the 1970’s was
structural, then the conclusion is not so obvious. Perhaps, conditioning on the structure of the
labor market, a downward-sloping Phillips curve still exists, even in the long
run. Indeed, more recent evidence
suggests that there is such a tradeoff after all, at least at low inflation
rates.
This is important because the US seems to be in the middle
of that tradeoff right now. If you
believe there is no tradeoff, if you believe the long-run Phillips curve is
vertical, then it's hard to explain how there's still any inflation at all
after almost 5 years during which we had first an extremely deep recession and
then a painfully slow recovery that has left output still well below any
reasonable estimate of the economy's potential.
After 5 years, we should surely be making our way toward the long run,
that vertical Phillips curve at full employment. If we're not, it must be
because demand is astonishingly weak, and that astonishingly weak demand should
be associated with an inflation rate that falls lower and lower until it
becomes negative. (This is the flip side of an overheated economy that produces
ever-accelerating inflation.) But that isn't happening. Instead we're seeing
something that looks a little bit like the old-fashioned downward-sloping
static Phillips curve, where low, but not necessarily falling, inflation rates
are associated with persistent excess unemployment.
I admit this isn't what I expected. I wrote a blog post a
couple of years ago predicting deflation. Even after having questioned the
conventional wisdom, I had found it too strong to resist. The vertical long-run
Phillips curve, I thought, might not be quite right, but it was "a close
enough approximation," and if I denied this, I'd face excommunication from
the Church of Macroeconomics. Deflation was coming, I thought. I was wrong.
I never got a chance to discuss this question with James.
During his last years he found it increasingly difficult to think and express
himself clearly, so it's unlikely we could have had a productive discussion.
But I can imagine what he would have said 20 years ago. He would have talked
about his contacts in industry and how they weren't about to destroy morale by
cutting wages, even if the economy stayed weak for several years. After some
discussion I think we would have come to the conclusion that the vertical
long-run Phillips curve was actually a pretty crummy approximation. That's
certainly what I think now. I'm going to have to pay more attention in the
future to what Hypothetical James Medoff has to say. He lives on.
