The Federal Reserve closely watches data on workers’ wages. A quick acceleration in wage growth is seen as a harbinger of inflation and may warrant the Fed quickly withdrawing monetary stimulus. But rising wages are a good thing. This presents a conundrum for the Fed: How much wage growth is too much?
But wages are only part of the story. From a business’s perspective, the more holistic measure of a worker’s impact on the bottom line is unit labor costs — the ratio of compensation to productivity, adjusted for inflation. (This statistic incorporates total labor compensation, which includes not only wages but also benefits, bonuses, etc.) The “unit” in unit labor costs is per hour, measuring hourly compensation and productivity. Unit labor costs rise when compensation rises, and they fall when workers become more productive.
On Wednesday, the Bureau of Labor Statistics released data on productivity and unit labor costs for the first three months of 2014. Relative to the last quarter of 2013, productivity declined 1.7 percent, and unit labor costs surged upward 4.2 percent (at compounded annual rates).
So, labor costs are really rising — a sign the economy is improving, meaning it’s time for the Fed to prepare to raise rates, right? As my ESPN colleague Lee Corso would say, “Not so fast!”
These series are extremely noisy — so it’s better to smooth out the data over the past few quarters.
The chart shows year-over-year change in unit labor costs (“unsmoothed”), and a four-quarter moving average of that change (“smoothed”). By these two measures, unit labor costs are rising by less than 1 percent — 0.9 percent to be exact. Although this is a backward-looking view of the data, it is the best way to detect trends, given the jumpy quarter-to-quarter fluctuations. So, unlike what is implied by the strong headline increase of 4.2 percent, the smoothed trend looks rather weak.
With wage growth still looking tepid — up 1.9 percent from a year ago — the trend in unit labor costs seems even weaker. If you’re looking for a reason that the Fed should start to taper off monetary stimulus, labor costs won’t do you much good.