Productivity and Wages: A Whiff of Inflation Wafting Through the Macroeconomic Air?

June 7th, 2016 9:50 am | by John Jansen |

Excellent piece on wages via Stephen Stanley at Amherst Pierpont Securities:

The productivity decline in Q1 was shaved, roughly as expected and in line with the modest upward adjustment to GDP for the period.  The 0.6% annualized fall in Q1 productivity took the four-quarter gain to 0.7%, still quite close to the 0.5% annual pace seen since the beginning of 2011.

However, the bigger story, as I had flagged, was the inclusion of new benchmark wage and salary income data for Q4 and Q1 that was incorporated into these figures for the first time.  Hourly compensation was boosted from a 0.9% annualized gain in Q4 to a 3.6% rise and the Q1 increase was bumped up from 3.0% to 3.9%.  These revisions take the four-quarter average to 3.7%.  This, in turn, fed through to increases in unit labor costs.  The unit labor costs advances in Q4 and Q1 are now 5.4% and 4.5% respectively, and the year-over-year increase accelerated to 3.0%.  This is significant, as any time unit labor costs are rising faster than price inflation, it means that labor markets are exerting upward pressure on inflation.  We have seen a noticeable uptick in core services inflation within the core CPI, which makes sense as services industries tend to be the most labor-intensive.

There are two broader points that I want to make about the wage picture.  First, though there seems to still be a consensus among Street economists and market participants that wage growth remains sluggish, in reality, wages have finally begun to move higher in earnest.  The anecdotal and survey evidence has been pointing to rising wages for a while, but the data were slow to fall into line.  Now they have.  The hourly compensation figures within this report have moved the most (which is typical, as these data tend to be the most volatile).  Hourly compensation gains have exceeded a 3% pace in 5 of the past 7 quarters, and, at 3.7% year/year, are running at roughly double the pace of a few years ago.  Meanwhile, average hourly earnings have picked up from a 2% trend to around 2½%.  Finally, the wages and salaries component of the ECI has been running at around 2% year/year in recent quarters, up from about 1½% a few years ago, and is set to pick up toward 2½% in Q2, when an outlier +0.2% reading drops out of the 4-quarter window.  Chair Yellen yesterday took note of the pickup in wages, citing the acceleration in average hourly earnings as “a welcome indication that wage growth may finally be picking up.”

Second, economists are missing a vitally important point about wages.  Though it took several years, Street economists finally realized that a slowdown in trend productivity growth meant that estimates of potential GDP growth needed to be moved lower in tandem.  However, they still apparently haven’t figured out that the same downshift in productivity growth means that wage gains will also ratchet down commensurately.  Firms are not going to give workers raises for productivity growth that is not occurring (at least not if they want to stay in business).  So, the consensus view on wages continues to be that anything less than 3% growth is sub-par/sluggish/inadequate because that was the prevailing pace prior to the last recession.  In reality, if trend productivity growth has slowed by 100 BPs, then so must the estimate of sustainable wage gains.  Although very few economists are recognizing it, we are already well on the way to an inflationary labor market situation.  While I agree that Chair Yellen signaled that there will be no rate hike in June and I understand why her speech was interpreted as suggesting that the Fed is on hold for a while (after all, that has been almost always been the smart bet for this Fed), I thought the most significant shift in Yellen’s rhetoric pertained to this question.  She argued that labor market slack is essentially gone, she acknowledged that wage growth is picking up, and she even alluded to my point about the relationship between productivity and wages (“recent weak productivity growth likely helps account for the disappointing pace of wage gains during this economic expansion”).  While she and her colleagues continue to have difficulty gathering the gumption to pull the trigger on a move until conditions are picture perfect, Yellen seems to be finally recognizing that the current economic landscape may not be consistent with the very easy stance of monetary policy.


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  1. 2 Responses to “Productivity and Wages: A Whiff of Inflation Wafting Through the Macroeconomic Air?”

  2. By Paul Mathis on Jun 7, 2016 | Reply

    Inflation is at a 50 year low.

    Trimmed mean inflation has not exceeded 3% in 25 years

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