Thursday, March 13, 2014

Is There Wage Inflation? and Is That a Problem for the FED?

In the recent Wall Street Journal's daily report, Jon Hilsenrath writes about a possible wage inflation happening in the U.S. job market as discussed by Torsten Slok and Joseph Lavorgna, who are both analysts at Deutsche Bank. On one hand, Torsten Slok points out that there has been increase in hourly earnings recently. Indeed, hourly earnings of production and non-supervisory workers increased by 2.5% from a year ago.
HourlyWage
This surge in hourly wage could make the FED worry about inflation pressure and change their timeline of raising the interest rate. However, as Mr. Lavorgna points out, this increase in hourly earning could be just a result of a decrease in average weekly hours worked as the case where,indeed, the average weekly hours  worked has dropped for last three months.
This drop in average hours worked could be a result of a bad winter we are seeing right now. But we have to be careful when reading Mr. Lavorgna's argument. We should take his argument strongly only if most workers are salaried workers since earnings for salaried workers are fairly less uncorrelated to the hours worked than earnings for hourly waged workers. That hasn't been the case recently; 59% of the total workers were paid on hourly basis in 2012. Therefore, there are factors we should be careful about on the both sides of the argument on the possible wage inflation. Once sunny days come again, we should look at the same data on hourly wage increase and change in hours worked to see whether wage is accelerating. 
Now, let's turn to the question: if wage inflation is indeed happening, does that mean there is a possible inflationary pressure coming?
The idea behind inflation driven by wage inflation is that when there is increase in aggregate demand for some reason and a following increase in demand for labor from firms, increase in wage accelerates. Facing the accelerating wage, the firms would raise their product prices.
However, this argument for wage inflation driven price inflation lacks some other factors that could make make the price inflation unnecessary. As discussed by Gregory D. Hess and Mark E. Schweitzer in their paper "Does Wage Inflation Cause Price Inflation?", the wage increase could be from increase in labor productivity. Also, the argument that the firms will raise their price to pay higher wage for workers isn't necessarily true if the firms are in competitive market and have no power over the prices. Moreover, in their paper they concluded the other way around that price inflation could drive wage inflation. Even though more study is need on the subject, the FED could be not worried about the existence of the wage inflation and the consequence of it if it exists for now.

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