Caroline Baum of Bloomberg dished up an excellent column today on why the place to look for inflation won’t be your paycheck:

In today’s world, any union demand for a wage increase is likely to be met with a shift in production: from Michigan to South Carolina for the auto industry; from North Carolina to China for textiles.

To the extent that labor has any negotiating power in a de- unionized, globally competitive world, wages are set “based on last year’s inflation,” said Joe Carson, director of global economic research at AllianceBernstein in New York.

Think of wages as a price: the price of labor. They happen to be the biggest share of compensation costs in services industries. That still doesn’t mean they cause inflation. Rather, they are a symptom of it.

It truthfully is as simple as that.  Wages are the price of labor and the domestic labor market has little pricing power because the price of labor internationally is lower than the US’s’, and even within the US, there are often lower-cost alternatives when prices rise to an uncompetitive level.  The column is worth a full read.  Baum’s analysis is spot on.

For unemployment rates to sustainably decline, real wages must decline.  Since nominal wages are exceedingly sticky, the Fed is implicitly (and occasionally lets slip explicitly) pursuing an inflationary strategy for bringing down wages.   If prices for everything else goes up, but the price for labor stagnates, the Fed has engineered a real drop in wage rates that should help bring the unemployment rate down.  Consumer prices have resumed climbing, roughly equaling their pre-recession levels, after having actually dropped during the recession–one of the first in the last sixty years or so.  A couple of graphs might help understanding what is going on.  The first one is the change in the Consumer Price Index level for all items (not ex-food and energy), it graphically depicts that prices have nearly shaken off the plunge of the recession and are almost at pre-recession levels.

FRED Graph

 

Labor prices have not enjoyed such a trajectory.  Labor costs fell during the recession, and have only reached about a third of their pre-recession levels.  Labor cost is not a perfect, but is a proxy, metric for wage rates.  The cost of labor contains things other than just the wages paid for it, but its main component is wages.  And if the cost index hasn’t reached its pre-recession levels such as consumer prices have, the most likely reason is that real wage rates have not kept pace with inflation.  Which is, of course, how it feels in the real world, and might explain a slowly-decreasing unemployment rate. 

FRED Graph

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