Why Yellen will put Main Street before Wall Street

The Fed Chair’s past writings reveal how she will favour growth in real wages over higher bond yields.

It’s one of the scourges of the age of social media, where your past postings get dragged up and held against you (this is not an invitation). If you’ve experienced this, then you can console yourself that you are at least in good company.

As a career economist, US Federal Reserve Chair Janet Yellen has a host of past writings to dig up, and many of them are available on the Internet. Top of that list is an effort published in the Quarterly Journal of Economics, just as much of the world was entering recession in 1990. Its title might be a bit dry – The fair-wage effort hypothesis and unemployment – but its contents are economic dynamite.

As the Irish economist David McWilliams describes in a recent blog, via Woodford Investment Management, the paper explains why people’s productivity will drop if they feel they’re not getting a fair wage, and how that will translate into unemployment.

It seems a fairly common sense argument – right up until about the third sentence, which contains the formula ‘e = min (w/w*,1)’ and I, for one, am lost.  But it’s interesting to note the fervour behind Yellen’s views. The paper refers to the biblical story of Joseph’s coat of many colours, as an example of jealosy and retribution, and it even quotes a little poetry (apparently from the bulletin board at a factory – see below).

The relevance of all this to financial markets is also pretty straightforward so long as you stay clear of the formulas. Janet Yellen is firmly of a view that for a healthy economy, it’s crucial people feel they’re being justly rewarded. As McWilliams points out, this is significant because ‘the American economy has recently seen:

  • real wages for the average guy fall sharply over the past decade
  • inequality rising out of all proportion with the top 1% gaining exponentially in comparison to the average worker
  • the return to capital, as opposed to labour, rising every year since the mid 1980s
  • stagnant productivity
  • labour force participation falling relentlessly as people opt out of the workforce.’

The inescapable conclusion is that Janet Yellan will worry first and foremost about the growth in real wages on Main Street, and much less about getting higher bond yields on Wall Street. So while there is talk of rates rising in the middle of this year, it's likely to be baby steps for a long while. Ultimately, this will probably lead to a burst of inflation, but Yellen likely won't care too much so long as she's achieved her primary goal – and right now the weight of argument seems to be on her side.

I am working with the feeling
That the company is stealing
Fifty pennies from my pocket every day;
But for ever single pennie
They will lose ten times as many
By the speed that I'm producing, I dare say.
For it makes one so disgusted
That my speed shall be adjusted
So that nevermore my brow will drip with sweat;
When they're in an awful hurry
Someone else can rush and worry
Till an increase in my wages do I get.

No malicious thoughts I harbor
For the butcher or the barber
Who get eighty cents an hour from the start.
Nearly three years I've been working
Like a fool, but now I'm shirking —
When I get what's fair, I'll always do my part.
Someone else can run their races
Till I'm on an equal basis
With the ones who learned the trade by mining coal.
Though I can do the work, it's funny
New men can get the money
And I cannot get the same to save my soul.

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