Dollars and Jens
Monday, February 12, 2007
I recently read an economic analysis that suggested that one risk to a benign inflation forecast was the potential mean reversion of labor's share of national income, thereby creating wage inflation. I'd like to note that this seems exactly backward to me.
Labor's share of income is lower than it has been historically, though very recently it's begun to tick up again. (It's probably, at this point, within the margin of error, though.) The change in the percentage of national income that goes to labor is necessarily the difference between unit labor costs and the GDP deflator; if the share of income going to labor is ticking back up, unit labor costs will be higher than broad measures of inflation, particularly consumer inflation. The best sense I can make out of what I read is that something would necessarily keep broad inflation measures in place, so that a relative increase in unit labor costs is going to mean an absolute increase in unit labor costs of the same magnitude — and then, unless one is worried about unit labor costs per se, presumably one fears these will feed back into broad inflation, causing that to rise, too.
I suppose it depends on the mechanism for the reversion to the mean, but what I've been envisioning for the past couple years — I like to think I'm not wrong, merely premature — has been that a renewal of competitive pressures results in a lack of pricing power for producers, while labor costs (per hour) continue to be driven by the tightness of the labor market just as they always have been; one would then envision the mean-reversion coming into effect by means of a decrease in broad inflation measures — though I should admit that the current unemployment rate probably suggests some unit labor cost acceleration.
It could be that the difference will come from an increase in unit labor costs, and it could be that the difference will come from a decrease in inflation. It could be some combination of the two; I don't see why more than all of it should come from the former.