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September 07, 2006
Another Bad Inflation Signal?
That would be the conventional interpretation based on yesterday's revision of growth in second quarter unit labor costs. From MarketWatch:
U.S. workers have been more productive, but have also been paid more than previously believed, figures on Wednesday showed.Revisions to quarterly nonfarm business productivity data show unit labor costs rose 5% in the past year, matching the fastest pace since 1990, the Labor Department reported. Read the full government report.
Higher unit labor costs could fuel inflationary pressures as firms struggle to recover their labor costs, and that could push the Federal Reserve to resume raising interest rates.Unit labor costs -- the cost of the labor needed to produce one unit of output -- had been subdued in the past few years, but now workers are capturing more of their share of the productivity bonanza."We now unquestionably have an issue with wage growth," said Stephen Stanley, chief economist for RBS Greenwich. Higher wages mean consumer spending should hold up, but it raises troubling issues about whether a new inflationary spiral is beginning.
The figures "will keep the Fed in an uncomfortable position regarding the inflation outlook," said Michael Englund, chief economist for Action Economics.
U.S. Treasury debt prices fell on Wednesday after a bigger-than-expected upward revision to second-quarter labor costs ignited fears that the Federal Reserve may need to resume its monetary policy tightening campaign...
"The major issue dividing the Fed is the danger posed by the bulge in labor costs, with some concerned that these costs will be pushed through into prices and others more confident that the monetary restraint the Fed has already put in place will prevent that from happening," said Pierre Ellis, senior economist at Decision Economics in New York.
"The numbers today really highlight that debate."
... and at The Wall Street Journal...
The latest data are "certainly good news for workers," said Stephen Stanley, chief economist at RBS Greenwich Capital. "They've been working against the strong head winds of high energy prices and a softening housing market. ... But these big revisions are something to be concerned about. I think we're in for a pretty extended period" of elevated inflation. (The data contributed to a drop in major stock indexes.
...and you get the idea. But not everyone was so convinced that the rise in measured labor compensation -- specifically hourly compensation in the nonfarm business sector -- was all that meaningful. Mark Thoma highlights comments by Paul Krugman, who attempts to repudiate any claims that labor compensation is rising by perpetuating a wrong-headed focus on narrow wage and salary data.
The best explanation I’ve heard comes from Dean Baker who suggests, based on the NIPA statistical discrepancy, that some capital gains (obtained, for example, via exercise of employee stock options) might be misclassified as compensation. (Conceptually, in the case of stock options, the compensation took place when the options were granted, not when they were exercised. Anything that happened to the value in the intervening time was a capital change rather than income, but the value of the options doesn’t show up on the income side of the national accounts until they are exercised.)
I'm not sure about the misclassified part. In terms of the national income side of things, any capital gains on the options may be a wash: We essentially have a transfer from firms (that would otherwise be able to sell their stock at market prices) to workers (who get the assets at a discount). In terms of labor costs, those transfers certainly count.
But the general point is well taken -- a jump in capital gains might well have a relatively transitory impact on labor costs, and not be indicative of a trend. Compare (as Dr. Baker suggests in his original post) the behavior of growth in the Employment Cost Index (ECI) with that in the hourly compensation series:
There are some differences in coverage between the ECI and nonfarm business sector compensation measures -- in the treatment of government and not-for-profit workers, for example -- but they are both broad measures that cover benefit payments as well as explicit wages and salaries. But the hourly compensation statistic - and hence unit labor cost calculations -- includes stock options. The ECI does not.
There was certainly nothing in the narrow measure of wages in the monthly employment report to suggest a 13.3 percent annualized jump in wages and salaries in the first quarter from the fourth quarter of 2005.
When Commerce's Bureau of Economic Analysis reported the revised figures last week, the lumping of the income gains in the first quarter suggested to many economists that the source was bonuses and options.
The most noteworthy part of the report was the significant upward revision of hourly compensation to a 13.7% gain in the first quarter from the previous estimates of a 6.9% increase. This is a reflection of compensation increases coming from stock options and bonuses which are reflected in the income side estimates of GDP. This is a one-off event and not a reflection of a big change in the underlying trend of labor costs.
That, and the stable-to-declining pattern of compensation in the ECI, should give us pause about concluding we are at the beginning of any lasting acceleration in the return to labor.
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Listed below are links to blogs that reference Another Bad Inflation Signal?:
» Is Labor Compensation on the Rise? from Economist's View
David Altig looks into whether recent upward revisions in unit labor costs represent another good wage signal or, as he prefers, another bad inflation signal. Okay -- ignore that one, but David does say sensible things, for the most part [Read More]
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