Sunday, October 20, 2013

Is there a sign of inequality in the price level?

When I was writing this post, I noticed that the aggregate demand-labor supply model (NGDP-LS) didn't do so well at the edges of the data (it did well from 1970s-1990s, but had deviations before and after) and it made me wonder if inequality didn't have something to do with it. In the post itself, I mentioned that the tiny amount of wage flexibility accounted for some of it. Here I want to speculate about a different mechanism: income inequality.

The mechanism would be that NGDP growth would be faster than labor supply growth as gains are taken by the rich, meaning that the derivative of the model (NGDP/LS) would be greater than the derivative of the price level P. This is what happens in the graph from the post linked above (model is blue, price level data is green):

I grabbed some inequality data from Saez to see if the ratio of the derivatives was correlated. It turns out it isn't unless you add an 18 year lag to the inequality data. It is possible it takes awhile for the price level to catch up with inequality, but I'll chalk this one up as inconclusive. Here is the relevant graph with the inequality data in green and the derivative data in blue along with a smoothing of the data:

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