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December 5, 2006
Is inflation whipped?
Maybe. (NY Times)
The Labor Department said that unit labor costs, a measure of what workers earn that takes into account their productivity, rose 2.3 percent in the third quarter, falling short of the preliminary estimate of 3.8 percent issued last month. Worker productivity increased 0.2 percent in the third quarter, more than the government’s first calculation of no change but far less than the productivity gains during the first half of the year.
Strong productivity is needed to help offset growing labor costs so they do not feed into inflation. In that sense, some economists noted that the 0.2 increase in productivity growth was troublesome.
A decline in productivity growth would mean somewhat tighter monetary policy would be warranted, all other things being equal. Let's go to Bernanke's speech from last week:
That said, longer-run trends in the growth of productivity are very difficult to predict. During the first half of the decade, productivity in the nonfarm business sector increased at an unusually high average annual rate of about 3 percent. However, according to current estimates, productivity growth slowed in the second quarter of this year and came to a halt in the third quarter. Moreover, the strength of recent hiring raises the possibility of subpar productivity growth in the fourth quarter as well. When all is said and done, however, I expect that the latest numbers will turn out to have been a reflection of the typical volatility in the data and some cyclical response to the slowing in economic activity, not a signal of a sea change in the longer-run outlook for productivity growth.
Even if productivity growth is sustained at a reasonably good rate, the slower expansion of the labor force will imply some moderation in the rate of growth of potential output over the next few years. In the very near term, that slower growth in the labor force needs to be taken into consideration when assessing the sustainability of given rates of expansion in economic activity. In the medium term, because the factors that affect potential output and thus aggregate supply also tend to affect aggregate demand, slower growth of potential output does not necessarily mean that inflation will be higher or that monetary policy will have to be tighter. Rather, the implications for monetary policy of a possible slowing in the growth of potential output depend on the extent to which such a slowing alters the balance of supply and demand in the economy. For example, as we saw in the second half of the 1990s, changes in expected productivity growth and potential output can significantly affect aggregate demand through their influences on income expectations and asset prices. The problem for policymakers is to identify, in real time, any changes in the prospective growth rate of potential output and to anticipate the accompanying effects on the balance of supply and demand.
Is it just me or are the markets trying like mad to find an argument for lower rates sooner? I think this would be a little frustrating for the Fed, which would like to bolster its inflation fighting credentials. Will next week's statement be more hawkish? Or will they admit that the slowing economy may necessitate easing? How would the latter be interpreted?
Posted by William Polley at December 5, 2006 4:33 PM
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Comments
Didn't the US yield curb flip? (For a while?) I thought it did but I'm not sure. Of course, that's not a perfect omen of the recession to come, but it seems that in certain circles there's a clear consensus that a recession IS coming, next year or so. In which case it would make more sense for the Fed to try and preempt that, rather than cause some unemployment and further output slowdown for 1% of inflation.
But maybe there is no recession. In this end, this question is more likely to decide the issue.
Posted by: Gabriel M. at December 6, 2006 2:00 AM
The previously reported sharp rise in unit labor costs was the primary reason I was as bearish as I was on inflation.
The revision have made me more optimistic on the prospects for lower inflation and rates.
Why shouldn't it?
Posted by: spencer at December 6, 2006 9:14 AM
spencer says, "Why shouldn't it?"
That question has been buzzing around in my head too.
See my next post. (Later tonight)
Posted by: William Polley at December 6, 2006 4:26 PM