Wage Inflation Does Not Just Explode

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Monday, 05 May 2014 05:14

The NYT had an interesting piece presenting the argument that the Federal Reserve Board should focus on wage inflation rather unemployment, not beginning to tighten up until wage inflation started to get above 3.0-4.0 percent, a rate consistent with its 2.0 percent inflation target. The piece included a counterargument from Torsten Slok, chief international economist at Deutsche Bank Securities, that if the Fed waited until it saw rising wage growth it would be too late. Inflation would then already be too high and getting out of control.

It is worth noting that there is no data to support Slok's view of inflation. Standard analyses show that the rate of inflation increases very slowly even in an economy where unemployment is below the level consistent with a stable inflation rate (i.e. the non-accelerating inflation rate of unemployment or NAIRU). According to the Congressional Budget Office, even if the unemployment rate is a full percentage point below the NAIRU for a full year the rate of inflation would only rise by 0.3 percentage points. This suggests that there would be very little risk in terms of higher inflation from delaying Fed tightening.