Source: Forbes
The Economic Cost Index for the second quarter got quite a bit of attention last week, probably more than it deserved. It increased 0.7 percent, up from the first quarter increase of below 0.4 percent. it was taken by many commentators on the financial networks to portend higher inflation. Indeed, many of them referred to “wage inflation.” That terminology is highly misleading.
An outsized increase from the first to the second quarter should have been expected when real GDP increase at an annual rate of 4 percent in the second quarter, up from a revised decline of 2.1 percent during the first quarter. Furthermore, productivity went negative in the first quarter and likely rebounded in the second. Higher labor compensation associated with higher labor productivity is not inflationary.
I learned in school that “wage push inflation” or, more broadly, “cost push inflation,” depended on what is happening to the money supply. If monetary policy is unchanged, higher wage and other costs are more likely to result in unemployment than in inflation. The Fed’s H.6. money stock statistics shows no recent increase from prior years, ranging between 6.5 and 7.0 percent growth, while M2 velocity has declined around 3 percent per year.
The simple facts of national income accounting also accounts for a bulge in employee costs and other income stats (wages, interest, profits, etc.) when the spending side (C, I, G etc.) is accelerating.
I agree with Janet Yellen that wages should be growing faster. I don’t much like her 2 percent inflation target, but I agree that wage increases not supported by money creation are not inflationary. “Wage inflation” is certainly a wrong and misleading term.