Kash at Angry Bear discusses the disconnect between the core and the headline numbers.
...individuals are finding that the purchasing power of their paychecks have been sharply eroded, as the price for the average bundle of goods that they buy has risen by nearly 5% over the past year. If workers can successfully demand higher nominal wages to compensate for this loss in purchasing power, then we might start to see nominal wages rising faster.... However, this depends crucially on the ability of workers to extract wage increases from their employers, which in turn depends largely on the strength of the labor market.
FYI, here's a 10 year series on year-on-year earnings growth from the BLS (not adjusted for inflation).
UPDATE: David Altig (macroblog) responds to Kash:
I don't have a lot to quarrel with in that assessment, but I think I would avoid phrases like "depends largely on the strength of the labor market." As we know, rising wages are not inflationary as long as unit labor costs are not rising -- that is, as long as higher wages are being driven by advances in labor productivity. A perfectly strong labor market is wholly consistent with perfectly stable prices.
I am away from my access to the dusty old FOMC transcripts at the moment, but my recollection from the record of the early 1970s was that Arthur Burns on several occasions pronounced that it was just not reasonable to expect inflation to persist because labor markets were so weak. History, I believe, revealed that as not such a good call. The reason it was not, in my opinion, is because it neglected the fact that inflation was, and still is, primarily a monetary phenomenon.
The issue really is not weak or strong labor markets. It does not take falling real wages to generate a decline in the inflation trend. What matters is the inflation psychology of the moment. The dreaded wage-price spiral can arise because workers and businesses alike believe that individual nominal wages and prices can be increased simply because all other wages and prices are changing. And they can come to those beliefs if they are convinced that the central bank will make it so. In this case rising wages are a symptom of the problem, not a cause.
He's entirely right that labor market slack, or lack thereof, is not the whole story. Productivity is critical as are inflation expectations and the perceived level of the central bank's commitment to inflation fighting. According to the BLS, productivity growth was 3.4% for 2004 (the lowest since the recession year of 2001). In the first two quarters of 2005, productivity growth was 3.2% and 1.8% respectively. I hope that this is a temporary setback and that we're not heading into an extended productivity slowdown reminiscent of the late 1970s. In just a few days (November 3) we'll get our first look at 3rd quarter productivity. In light of this discussion, I'm sure the usual suspects will be all over it, and I'll reserve additional comment or speculation on the future direction of productivity growth until then.
Labor market slack is still relevant to the matter at hand, but if a supply shock causes wage growth to exceed productivity growth, that would test the Fed's inflation fighting resolve--with or without slack. In fact, a central bank might even be more tempted to ease up on the price stability goal if there was slack. (I think that is Altig's point about Burns in the 1970s.)
It's too early to say if a process like this has begun. Such things are more apparent after the fact. However it is appropriate, I think, to have it on the radar at this point. And because it is on my radar, I'm really anticipating the November 3rd productivity release.
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