The Disappearing Inflation Problem

Today's most interesting data news: wage and salary payments to workers in 2006 now appear to have been far, far lower than were previously estimated. The Wall Street Journal reports on today's new data from the BLS:

Labor Costs Revised Lower As Productivity Grows 0.2%

WASHINGTON -- U.S. productivity growth was mildly stronger during the summer than first thought, while unit labor costs were revised sharply lower for two quarters in a favorable sign for inflation.

...Third-quarter unit labor costs -- a gauge of inflationary pressures -- rose by 2.3%. Economists expected a 3.2% advance. [The BLS] originally estimated a 3.8% increase for the third quarter. Unit labor costs in the second quarter decreased, falling 2.4%; originally, Labor reported a 5.4% surge.

Compared to a year earlier, unit labor costs were 2.9% higher; in Labor's last productivity report, it estimated the year-over-year climb at 5.3%.

That's a big, big difference; whereas a week ago it looked like the cost of labor had risen by more than 5% over the past year (a fact stridently noted by many inflation hawks, including members of the Fed), now it appears that labor costs have actually only been rising by just over half that rate. Note that unit labor costs are of great importance to inflation-watchers because they describe how firms' costs are changing (labor being the biggest single cost of most firms).

Note that this sharp change in the inflation picture was actually foretold by last week's GDP revision. In that revised GDP report, wages and salaries were about $100 billion lower in early and mid-2006 than had previously been estimated, as Rex Nutting of Marketwatch reported.

The following picture shows what the most up-to-date earnings data looks like. The green line shows real compensation, which is the data that matters from the point of view of workers. The red line shows unit labor costs, which is how that compensation affects the costs of firms (taking into account changes in worker productivity). This latter line is the one that concerns inflation-watchers. A 2.9% rise over the past 12 months sure looks a lot less worrying than a 5%+ increase did.



So today's data can join the growing queue of reports (see today's column by Irwin Kellner for more examples) suggesting that inflation is not the major problem that the US economy is facing today; rather, a significant slowdown in economic growth seems to be becoming the much more pressing danger.