Energy prices and real wage trends

November 12th, 2018 at 8:03 am

I’ve got a piece up in today’s WaPo on some of the economic and social implications of the recent tanking in oil prices. Obviously, such prices jump around, and OPEC is talking about reigning in supplies, so the negative trend could reverse. But the points of my piece are a) low oil may be a boon for consumers at the pump, but it’s inconsistent with sustainable growth, and b) especially post-midterms, it’s time to start talking about taxing carbon. I suggest raising the gas tax as a good start, which, as I show, is more bipartisan than you thought.

The piece also has a figure showing the impact of changes in energy prices on the growth of real wages of middle-wage workers. I point out that the correlation between those two variables is much higher now than in the past.

The “energy effect” in the figure is simply the difference between real wage trends with and without energy costs. The first figure below shows wages deflated both ways. The blue line is real hourly wages (production, non-supervisory workers), yr/yr, and the green line is wages deflated by the CPI without energy costs. Therefore, when the two lines are broadly coincident, as in the earlier decades, it implies changing energy costs weren’t much of a factor in real wage growth outcomes.

The second figure shows the same CPI-deflated real wage trend but plotted against the difference between the two series in figure one, the idea being that wg/cpi – wg/cpi_no_energy nets out the energy impact.

Source: BLS, my analysis.

Source: BLS, my analysis.

Does faster wage growth imply passthrough to faster price growth? Not necessarily. (Though see update at the end.)

November 6th, 2018 at 4:59 pm

Introduction

As long as we’re sitting here on pins and needles re the midterms, let’s distract ourselves with some analysis of the state of the wage/price passthrough. Though not quite at the level of flipping the House, this is important information regarding inflation, interest rates, and Fed policy.

As the job market has improved, wage growth has picked up. Last week, two closely watched hourly wage series—the Employment Cost Index and the Establishment Survey wage—hit 3 percent growth on a yr/yr, nominal basis, about double their growth rate from five or six years ago.

Though it’s the highest growth rate of the expansion so far, 3 percent is a lower nominal growth rate than earlier periods when unemployment was as low as it is today (3.7 percent). That’s partly of function of slack still left in the job market, low productivity growth, and low inflation. Nevertheless, many economic commentators have argued that as tight labor markets push up wage growth, faster inflation will follow, as employers pass through higher labor costs to consumers. Anecdotal news reports back this up, suggesting that after years of historically low inflation, employers are finally feeling some pricing power, which they’ll use to help maintain their profit margins as labor costs rise.

This note examines the validity of that claim in today’s US economy. Using data covering about the last 30 years, I find that while wages and prices correlate, the correlation has fallen over those years and, at least in the national data, there’s little evidence that faster wage growth will lead to faster price growth. To be clear, this is not a claim that inflation will stay around where it is today as the economy continues to close in on full capacity. But it is a claim that if price growth does accelerate, it will not necessarily be due to faster wage growth.

Recent average wage and price trends

To avoid cherry-picking, wage analysts often use principal components analysis to combine various wage series (such analysis works like a weighted average, down-weighting noisier relative to more stable series to extract a more representative signal of underlying wage growth). My version, which mashes up five wage and compensation series (including the two noted above) is shown in Figure 1.

The series is quite cyclical, suggesting there’s a wage Phillips curve through which slack maps onto the pace of wage growth, along with the other determinants noted above: inflation and productivity (changes in labor-force demographics matter too). Most recently, nominal wage growth bottomed out at around 1.5 percent in late 2012 and is now closing in on 3 percent.

Figure 2 adds two inflation series to the wage series, also in yr/yr changes: the PCE deflator and the core PCE deflator. A few key patterns appear. While wage growth has gone up and down since the mid-1990s, price growth, especially the core index, has stayed “well-anchored” around the Federal Reserve’s 2 percent inflation target (though the target was only formalized in 2012).

Due to data constraints, my 5-wage mashup series only starts in the early 1980s, but a longer series (Figure 2b), the BLS production, non-supervisory series that begins in 1964, shows roughly the same pattern with the same break point in the mid-1990s.

The rectangle at the end of the figure highlights the most recent dynamics of this relationship, with the wage clearly accelerating and the core price index stable at 2 percent, where it has been for the past five months. Of course, these few data points don’t make a statistical case regarding passthrough, so for that we turn to simple models of the process.

Wage-price passthrough in regression models

I begin with a simple model using quarterly data to regress yearly PCE price changes on the lagged wage series from Figure 1, import and energy price controls, and a measure of labor market slack. However, passthrough regressions typically adjust for productivity growth so that the variable measures unit labor costs. The theoretical rationale is that to the extent that productivity improvements offset higher labor costs, price passthrough is less needed to maintain margins. The regression also includes a lag of the DV.

ULCs are measures of compensation per unit of output and are constructed in this case as yr/yr nominal wage growth (using the 5-series mashup series) minus yr/yr productivity growth. However, it is notable that the results hold if I use just the wage, unadjusted for productivity growth, or if I swap in the BLS ULC series for my constructed version. To smooth out the volatility in the wage and productivity series, I use a three-year moving average for both variables. Again, results are similar without the smoothing.

To capture the changing nature of the passthrough, I run rolling regressions in 10-year windows. The plot of the ULC coefficient around its 95 percent confidence intervals is plotted below (Figure 3). The passthrough starts out both economically and statistically significant and then falls to essentially zero around the mid-2000s.

As the next figure reveals, running a VAR with the same variables (with six-quarter lags in prices and ULCs), and then shocking the ULC variable generates the same result. The price response function is flat and the confidence intervals consistently cross zero.

Finally, a test with four lags finds that inflation “Granger-causes” productivity-adjusted wages (the null hypothesis that this isn’t the case is rejected), but not the other way around, with the latter being the passthrough channel.

Summarizing, based on this evidence, the recent acceleration in wage growth may not bleed into price growth as much as some recent commentary suggests, as this passthrough relationship has significantly weakened over time. Notably, other more extensive research by Federal Reserve economists comes to similar conclusions.

There are, however, a few important caveats. For most of the past decade, the Fed’s key policy rate has been at zero, the labor market was slack, and inflation was below target. None of those conditions prevail today, and even while some were controlled for in the above analysis, it is possible that earlier passthrough patterns could return. Also, national data of the type used herein can obscure important difference across geographical areas. Most germanely, research by Goldman Sachs economists (behind a paywall) has shown that even while national price Phillips Curves have been flat, those in various cities have had fairly steep slopes. It would thus be useful to look for passthrough in panels of geographical units over time. Of course, if passthrough does show up in that framework, such results, in tandem with those above, suggest that in non-metro areas, passthrough must be extremely muted.

At any rate, the findings suggest yet another reason for a data-driven Federal Reserve to carefully test all assumptions about the extent to which our historically tight labor market will lead to lead to wage gains that will, in turn, push up prices. There are a few links in that chain, and they’re not as binding as many appear to think.

Data note: All data are from BLS or BEA, with the exception of the CBO natural rate variable, used to construct the labor market slack variable (unemployment – natural rate).

Update: I just stumbled on a new piece from Daan Struyven from the GS research team who runs a similar analysis to that above but with arguably better data, and he finds significant passthrough (behind a paywall). He uses a panel data set of 167 industries covering the years 1998-2017, finding that a one percentage-point wage (or ULC) acceleration raises the price level by about 0.4 percent cumulatively over two years, with about 2/3’s of the action in year one. Should wage growth accelerate by half-a-point–from 3 to 3.5 percent–core PCE inflation might then get a 20 basis point bump from the passthrough. 

As I intimated above, I like the panel approach better than my own, and suspect this model is picking up a more reliable signal. If so, that’s a feature, not a bug, for the future path of core prices, as symmetry around the Fed’s 2 percent target means that the years of downside misses must be offset by a period of above target inflation.

Another strong jobs report yields critical insights

November 2nd, 2018 at 10:02 am

The nation’s payrolls added 250,000 jobs last month, the unemployment rate held steady at a 49-year low, the closely watched labor force participation rate increased, and year-over-year wage growth broke 3 percent for the first time since 2009. Given that inflation has been running a bit short of 2.5 percent, this means workers are finally seeing real gains in the buying power of their paychecks.

Wages were up 3.1 percent for all private sector workers and 3.2 percent for middle-wage workers, suggesting that the tight labor market is generating broad gains, not just helping those at the top of the earnings scale.

One slight caveat re wage growth is that in the previous October (2017), hourly pay in this series fell four cents in nominal terms, a rare event. Thus, the base off to which this October’s wage gain is compared was unusually low. However, the moving-average figures below, which smooth out such monthly noise, show clear acceleration in the pace of wage gains. Also, averaging over the past three months shows hourly wages growing at a very strong 3.6 percent annual rate compared to the prior three months. This represents a clear acceleration over the prior two “quarters,” when annualized growth was 2.6 and 3 percent, respectively.

In other words, the U.S. job market is tighter than it has been in decades and this dynamic is revealing at least two important insights. The first, which we knew, is that slack matters: the absence of full employment saps worker bargaining power and constrains wage growth. When we move toward full capacity in the job market, workers get back some of the clout they lacked, and employers must share more of the gains with them.

Second, and this most economists did not know, is that there was and still probably is more room-to-run in the labor market than conventional wisdom believed and thus more room for non-inflationary gains. The distributional implications of this critical insight cannot be overstated: full employment provides the biggest gains to the least advantaged, too many of whom have long been left behind in previous economic expansions.

Our monthly smoother, which averages over 3, 6, and 12-month windows to get a better look at the underlying trend of job growth, shows that trend job gains are north of 200,000, more than enough to push our already low unemployment rate down even further. Is this trend persists, and even if it fades some, it will likely take the jobless rate down to below 3.5 percent in coming months.

As noted, the tighter job market has delivered faster wage growth. The smooth trend in the next two figures show a slow staircase of wage gains, from around 2 percent in 2013, to 2.5 percent around 2016, to closing in on around 3 percent now. Contrast this staircase with the “elevator down” shortly after the recession. This pattern of sharp wage-growth losses and slow wage-growth gains is precisely why it is so important for policy makers to preserve and build on the gains generated by the close-to-full-capacity job market.

This admonition is especially the case when we consider how “anchored” price growth has been. The next figure shows that as the unemployment rate has fallen well below the Fed’s estimate of the “natural rate”—the lowest rate they believe to be consistent with stable inflation—price growth remained at the Fed’s 2 percent target. This anchored inflation dynamic has held even as wage growth has picked up.

Based on these relationships, I and others have suggested the Fed consider pausing in their interest-rate hiking campaign. This is a unique moment for a truly data-driven Fed to build on these critically important labor market gains that are finally—nine years into the expansion—deliver some potentially lasting gains to middle- and low-wage workers.

Finally, a political note. In applauding this strong report a few days ahead of a uniquely important midterm, it is impossible (for me, at least) to discuss the current job market apart from its political implications. First, one reason for the very tight labor market is the tax cut and spending bills that were added to the deficit, which at 4 percent of GDP, is far higher than it should be at this stage of the recovery. This deficit spending is boosting the growth rate by perhaps a percentage point, which I (along with most other economists) believe will start to fade later next year.

In other words, the policy agenda of piling onto the budget deficit when the economy is already closing in on full employment has, to its credit, revealed more labor capacity than most economists and the Fed believed was available. But it is also robbing the U.S. Treasury of much needed revenue at a time when we’re going to need more, not less, revenues to meet the fiscal challenges we face.

Moreover, Trump is clearly building on trends he inherited. His constant refrain that the job market was terrible before he got here is the fakest of fake news. And then there’s the reckless trade policy, the hateful rhetoric with its murderous consequences, the chaotic dysfunction at the highest levels, and the never-ending stream of lies.

I like a full employment labor market as much—surely more—than anyone. But I guarantee you it’s possible to achieve it without all the hate.

Wage roundup: Amplifying new work on an important topic.

October 23rd, 2018 at 4:02 pm

There’s been some interesting wage analysis in recent days and the findings are worth collecting and amplifying. Some of what follows is technical, but the punchlines are straightforward:

–As I’ve always stressed up in these parts, tight labor markets are especially beneficial to lower-paid workers.

–Even so, wage inequality remains alive, well, and connected to the recent boom in corporate profitability.

–In earlier periods, unemployment rates as low today’s would have generated faster wage growth. The reasons for today’s under-performance are likely slack, slow productivity growth, and weak worker bargaining clout.

This first figure, from my great pal Larry Mishel and Julia Wolfe, uses high quality administrative data to reveal key aspects of the real annual earnings’ story over the past few decades. The top line shows that the average earnings of the top 1 percent—about $720,000 in 2017—are up 157 percent since 1979, compared to 22 percent for the bottom 90 percent (2017 avg: $36,000). FTR, the top 0.1 percent were up 343 percent over these years (2017 avg: $2.8 million).

Moreover, and this is really telling, there are but two periods in the figure when the average for the bottom 90 goes up: the full employment latter 1990s and around 2015. The latter was a year of weirdly low inflation (about zero), so that’s anomalous. But that positive slope in the latter 90s confirms the importance to this discussion of very low unemployment. In fact, unemployment is even lower today, but I’ll get to that in a moment.

The other important pattern in the figure is the sawtooth movements for the top 1 percent around 2000 and 2007. If you follow the stock market, and particularly the patterns in capital gains realizations, those spikes are familiar, but why should they show up in paychecks? The answer is that in these data come right off W2 wage filings, which include exercised stock options. The diverse pattern between the top and bottom lines in the figure underscores the narrow reach of stock market gains.

But why aren’t middle and lower-wage workers seeing much in terms of wage gains these days? This is the topic of very thorough bit of work by Ernie Tedeschi in the New York Times. Ernie goes over pretty much every reason you could come up with regarding the question just posed; here are some of the findings I found most germane:

–If you look solely at unemployment, you’d think the job market is at full capacity. If you look at more broad indicators, you might not be so convinced.

–Low inflation tends to correlate with slower nominal wage growth, but the gap in wage growth between now and 2000—the last time we were at full employment—is only partially explained by slower price growth.

–Contrary to claims by Trump’s CEA, as Larry and I showed a while ago, benefit growth can’t be crowding out wage growth, because nonwage comp isn’t outpacing wages (we showed the nonwage share of comp has been flat in recent years; we also argued, as does Ernie, that demographic change doesn’t explain the wage-growth gap).

–Slow productivity is surely in the mix, but it’s only a partial explanation.

Let’s pause for some analysis of that last point, as productivity is key to this debate (and key to living standards), but sometimes gets short shrift. Also, advocates of this explanation, of which I am one, sometimes argue that it is a more binding constraint than is necessarily the case.

A recent paper by Janet Yellen, which Ernie cites as well, introduces a model that I’ve sort of replicated (I’m using some different data and not imposing some of the constraints she does on the model’s coefficients, though the results I’m about to show are similar if I do so). Yellen’s model includes slack, inflation, and productivity growth. All three variables significantly drive nominal wage growth, but here’s some evidence that slowing productivity growth helps to explain the gap which is the focus of Ernie’s report.

I’ve run the model using my “mash-up” wage series (five different series combined, so as to avoid cherry-picking) through 2010 and then forecasted forward using the actual values for the independent variables. The first figure shows that the model does a decent job of predicting wage growth out-of-sample. Most notably, even with the decline in unemployment (actually, the gap between unemployment and CBO’s estimate of the natural rate), this version of the model does not predict faster wage growth 8 years after the estimation period.

But if I exclude productivity growth (the Yellen model employs a smooth trend in productivity growth), a clear overshoot occurs. It’s not a huge effect, for the record, but it’s there.

To be clear, I could have done the same exercise with inflation and slack but economists have focused on slow productivity growth because it is, as I show in this post, an essential indicator of potential (average) wage growth, and its slowdown is therefore a real constraint on living standards more broadly.

However, as I also stress in the link just above, the role of bargaining power must not be overlooked in this productivity discussion. Even at low productivity growth, wages can grow more for some groups than others (distribution within the national wage share of income), and the wage share of national income, which has tanked in recent years, can rebalance in favor of workers. In fact, that dynamic is attractive from the Fed’s perspective, as it supports non-inflationary wage growth.

The final recent wage report to bring to your attention comes from researchers at Goldman Sachs (no link); it focuses on the distribution of wage pressures as the job market tightens up. Their table below makes a point I’ve long stressed: the less you earn, the more tight labor markets help you. The coefficient on slack (top row) is 2x that for low-wage as upper-middle-wage workers, and it is insignificant for high-wage workers. Note also, as in the Mishel/Wolfe chart above, the correlation between corporate profits and high-wage growth.

The other important finding from their regressions is the structural downshift of the model’s parameters in the post-2010 period, though not for low-wage workers (state minimum wage increases are likely in play here). The last figure shows that using the parameters from their full model predicts average wage growth close to 4 percent by late next year. But if the prediction is made based on the more recent, diminished correlations, then wage growth hardly budges from its current pace, even as they predict the unemployment rate to fall significantly below today’s levels.

Source: GS Research

Putting it all together, tight labor markets are as important as ever, though slow productivity growth and weak bargaining clout are still, even at 3.7 percent unemployment, operating as wedge between growth and broadly shared prosperity. The policy implications point towards the importance of patience at the Fed and more collective bargaining (and much better labor policies, including minimum wages/overtime, but that’s for another post). Workers need both tight labor markets and the power to steer more of the benefits of a full capacity economy into paychecks, not profits.

An important correction: The U.S. does have a carbon tax. But it needs some serious attention.

October 22nd, 2018 at 3:57 pm

I’m am avid listener to the NY Times podcast, The Daily, and I much enjoyed, if that’s the right word given the difficult topic, last Friday’s show on the urgency of pushing back on climate change. The show included an insightful discussion with recent Nobel laureate William Nordhaus on the importance of taxing carbon.

But somewhere in there (not in the Nordhaus section), it was asserted that the U.S. federal government does not tax carbon. In fact, such a tax exists: it’s the federal gas tax. Given that this is the carbon-tax-that-time-forgot, I can understand the mistake (the reporter was probably thinking about more sweeping, new taxes on carbon emissions). But there are two strong reasons for raising it. One, to more accurately price the social cost of carbon consumption, and two, to pay for our eroding transportation infrastructure.

The federal gas tax has been stuck–in nominal terms!–at 18.3 cents per gallon since 1993. It hasn’t been adjusted for consumer inflation, for the increased cost of transportation maintenance, for the improved fuel efficiency of today’s fleet, or for the slower growth over the past decade in total miles driven (see the figure below, showing a 12-month rolling average of total vehicle miles driven, in billions; people traveled a lot less in the downturn, such that miles driven are down by 480 billion relative to the pre-2007 trend; that’s good for the climate; bad for the trust fund coffers).

To be clear, those last two factors are roundly welcomed. But they also mean we’re collecting a lot less than we should be, which besides under-pricing carbon, is why a) the federal transportation trust fund is always broke, and b) our roads and mass transit suffer from persistent under-investment, especially in state that haven’t picked up some of the slack (the average state gas tax is 24 cents/gallon).

The tax analysts at ITEP do an excellent job of following this issue, but it is one that should be far more prominent. They calculate that to keep pace with the factors just noted, the federal gas tax today would need to be about 50 cents/gallon.

Since the federal gas tax was introduced in the 1930, this is the longest we’ve gone without raising it. Even President Reagan raised the damn thing (from 4 to 9 cents, in 1983)! As I document here, every once and a while, grown-up politicians propose an increase, often a bipartisan one. (BTW, as electric vehicles become more common–they don’t use gas; they do use roads–a per-mile user fee may be necessary to support transportation infrastructure).

As the Daily podcast stressed, there are policy makers who increasingly realize we must tax carbon, though especially in the age of Trump, they tend not to speak up much in this country. Moreover, it’s typically easier to add to an existing tax than introduce a new one.

Of course, I admit that it’s awfully hard to imagine a federal gas tax increase getting anywhere these days. But we’ve got to try, and we certainly can’t forget that it exists!

 

Source: DOT, Fed Highway Admin.