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Monday, November 02, 2015

'Are Wages Useful in Forecasting Price Inflation?'

Rhys Bidder of the SF Fed (I should probably note that these are his views, not the Fed's, though I hope the Fed is paying attention):

Are Wages Useful in Forecasting Price Inflation?, FRBSF Economic Letter: Wages and prices are closely related. Wages are an important part of businesses’ costs and are thus tied to their pricing decisions. Similarly, people take the general level of prices into account when figuring out how much pay they deserve for their work. It is intuitive, therefore, that wage data could contain important information about prices and, in particular, might be useful for forecasting price inflation. Indeed, the recent declines in some wage indicators following hints of strengthening earlier in the year have raised questions about what this might mean for future inflation.
In this Letter I summarize what research can tell us about whether or not wage data are, in fact, informative for future price inflation. Overall, the literature suggests that wages do not provide significant additional information beyond what can already be gleaned from other sources, including prices themselves. ...
In classical economic theory, the labor market clears at a nominal wage that makes labor supply equal to labor demand. Both supply and demand depend on the face value of wages relative to the overall price level—typically called the “real wage” because it shows how much can be bought with the wage at current prices. The real wage determines the benefit to the worker of working and the real cost to the business of employing that worker.
In the long run, the real wage is determined by factors such as productivity, bargaining power, and the ability of firms to mark up prices over costs. Consequently, prices and nominal wages must adjust relative to each other to be consistent with these fundamentals. ...
However, while the connection between wages and prices is relatively well understood in the long run, their short- to medium-run relationship is not so simple. Wages and prices may fluctuate relative to each other in response to transitory influences and to restore their long-run relationship. The bargaining power of firms and workers may vary and productivity may change temporarily. Even if there are no long-run trends in these variables, there may be changes in their steady-state relationships that lead to transient but long-lasting adjustments. These phenomena introduce complicated dynamics into the relationship between wages and prices that determine how useful wage data are for forecasting inflation. ...
These results do not imply that wages and prices are unrelated. Certainly they are tied together in the long run, and wage data will surely contain some information for future price inflation. However, after incorporating information from prices and activity measures, the marginal additional benefit of using wage data appears small. ...
Fundamentally, the weak forecasting power of wages for prices suggests that unexpectedly high or low inflation could occur regardless of the recent behavior of wages. Thus, as ever, policymakers must be vigilant to ensure policy is consistent with the targeted inflation rate. ...
Researchers have extensively studied how wage data might help predict future price inflation. The overall conclusion of the literature is that wages generally provide less valuable insight into future prices than some other indicators. In fact, models that do not incorporate wages often result in superior inflation forecasts.

    Posted by on Monday, November 2, 2015 at 10:27 AM in Economics, Inflation, MoneyWatch | Permalink  Comments (10)


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