Flat Phills, all around

May 7th, 2017 at 12:26 pm

I’ve got a piece in today’s WaPo on the diminished correlation between the tightening labor market and wage and price growth. This is evidence of the well-known flattening of the “Phillips Curve,” the statistical relationship between nominal wages, prices, and tightness in the job market.

The figure below shows annualized growth rates of a) core PCE inflation and b) nominal wages of blue-collar factory workers and non-managers in services over numerous periods of falling unemployment. Since the 1980s, those growth rates have been falling. In the current episode of falling unemployment, price growth has been particularly slow. Those familiar with this phenomenon will recognize this observation as the flipside of the question we were asking when unemployment was 10 percent: “why isn’t the rate of inflation falling.”

Source: BLS, BEA

My WaPo piece gets into the why’s and why-this-matters. Here, I just wanted to post some complementary evidence.

A simple model does a decent job of predicting yearly changes in the ECI wage index. The model includes two lags of the dependent variable and a measure of full employment: u-u*, or unemployment minus the CBOs estimate of the full employment rate.

The figure shows that the model tracks wage growth through the tight-labor market of the 1990s, but over-predicts in the 2000s. Toward the end of the series, there’s a hint that ECI wage growth may start to underperform the forecast.

The growth in the blue-collar, non-managerial hourly wage has also flattened in recent months, even as the job market has tightened further (the smooth line is a 6-mos moving average).

Finally, Kalman filtering is a useful statistical technique to test whether and how much an economic relationship–in this case, the correlation between ECI wage growth and u-u*, or labor market tightness–is changing over time. The last figure shows that in a model with yearly ECI changes as the dependent variable, the coefficient on u-u* has drifted up and is about zero now. Moreover, the upward drift accelerated a lot in the last few years.

I say what I think this means–and cite many explanations from others whom I bugged about it–in Monday’s paper. But the facts of the case look pretty solid to me, at least for now.

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9 comments in reply to "Flat Phills, all around"

  1. Smith says:

    For starters, totally not understanding your chart showing inflation at 2% 1992 to 2000. It was averaging 2.6% and this is important in the debate over what should the current inflation target be (obviously not 2%).
    Could you label what the blue bar on the chart represents? It can not represent what we commonly think of as inflation.

    • Jared Bernstein says:

      Sorry–text said “core inflation,”–now says “core PCE inflation,” as does figure.

  2. Smith says:

    You are all wrong because you’re conceding that inflation should be controlled by hiking interest rates to slow the economy, hold unemployment levels steady if not induce greater unemployment, in order to keep wages from rising. The thought chain in your process goes like this:
    interest rate hike -> lower investment and higher costs of existing debt -> slower growth -> level or increased unemployment -> level wages (or lower wages especially for new hires) -> steady inflation rate
    One must believe in a natural rate of employment, unknowable in advance even if it did exist, but it doesn’t
    One must ignore Verdoon’s observation about productivity.
    One must deny that other methods exist to control inflation other than by exploiting workers, especially the most vulnerable, those with the least formal education and opportunity, and in the lowest income levels.

    You are all about fine tuning this system instead of questioning the basic premise about controlling inflation with increased unemployment. It is wrong to raise interest rates to control inflation even if the inflation rate is closer to a healthy 3% (caused by wage increases, not commodities, but inflation is all about businesses fighting to recover the wage increase with price hikes) Our current sub par inflation below 2% level is a cruel joke.

    Also, exactly how and why did U6 drop a million in three months? Youth wants to know.

  3. Smith says:

    You need to consider that a slow growth economy, with slack in the labor market, weak wage pressure, and low inflation, can coexist with record corporate profits and economic stability. Perhaps there may be debt bubbles compensating for stagnant wages, but this may not be a requirement. The model does tend to presume larger inequality because higher income levels by definition have more wage leverage or they wouldn’t be high in the first place. High incomes does not include 80% of college graduates who fall out of the top 10% income group, due to shortage of what we call high skills jobs. Just look at stagnant average wages of college graduates for proof. They have only 2.5% unemployment because they take jobs away from those with less formal education who are 5% unemployed, not including those who left the labor force entirely.
    But, even the crappy economy we have now could sustain Trump through two terms since Obama survived an even crappier era owing to the Bush legacy. One could perversely wish for 1% inflation sinking the economy and resulting regime change in 2020

  4. AngloSaxon says:

    Don’t get hit by the lags guys. I keep on saying this and we must understand how the BLS puts together wages. When wages spike, they spike. Fast. Don’t let the 90’s illusions fool you. That level of productivity was not normal and was not sustainable.

    • Peter K. says:

      Larry Summers in his Financial Times column:

      “It has been surprising, in the face of the labour market tightening, that there has not been more evidence of accelerating wage inflation. A reasonable conjecture is that this reflects workers cowed by the possibility of being replaced by technology or foreigners. Indeed, given the tightness of the labour market, workers appear relatively reluctant to quit jobs.”

      There is also the successful anti-union campaign of businesses and the rightwing these past 40 plus years.

      Wages haven’t spiked since the 1970s and we’re in a new era of political economy.

  5. Ed Brown says:

    I admit to lacking economic knowledge but usually I am OK at math. But I might be off base here. Anyway: i don’t think you want to examine the relationship between wage growth and u-u*. To the extent that the CBO’s estimate of the full employment rate changes throughout time, we have mathematical consistency problems. For instance, if the CBO considers wage growth (or anything highly correlated to wage growth) in determining u*, and I am guessing that they do, it would probably be better to just use u instead of u-u*.

  6. Smith says:

    I get that you argue for both higher minimum and expanded EITC, but EITC is corporate welfare that rewards substandard pay employers and punishes fair wage employers. It is furthermore a boondoggle program rendered obsolete by New York and California where the phased in $15 minimum totally supplants EITC by a factor of 2 at least. You’re also ignoring the program creep that awards EITC to families very near the median income levels, thus starving needed funds for quality childcare. Low incomes in poverty are statistically households with 1/2 a wage earner. EITC for single adults without children is a bad and wasteful idea. Employers with Real jobs with decent wages can not compete with employers who are subsidized by your EITC. There’s a reason Reagan, Bush, and Greg Mankiw support EITC

    • Smith says:

      While awaiting moderation, a way in which EITC for people with children is considering those with $15 / hour jobs working only part time or part of the year. This matches exactly though with my point about poverty caused by households with half a wage warner. Again, the cost of quality childcare substantially dwarfs any benefit from EITC. New York, Massachusetts, and New Jersey average $20,000 a year for primary school and high school. EITC privatizes and buries the need for childcare, good jobs, and flexible work schedules.