Revised and Updated Labor Costs Still Tame

Some people will look at the new second quarter figure for unit labor cost in this morning’s productivity report and conclude that labor costs have become an inflation problem. Unit labor cost was up at 4% annual rate in the second quarter and up 3.1% from the same quarter a year ago. As I’ve said before, though, this series is volatile, and the appropriate way to analyze it is to smooth the quarterly changes. Taking into account the revisions and the latest update, my smoothed series now looks like this:



It stands at 1.7%, still quite close to the 1.5% center of the assumed hypothetical target range. In fact, on the off chance that the Fed really is targeting unit labor costs, let me offer my personal congratulations to each of the FOMC members right now for coming so close. Let me also say that, if I believed that the Fed were targeting unit labor costs, I would be pretty confident that we would not see any further interest rate increases, at least not in the next 3 months (and certainly not this afternoon). When the economy is facing a possible recession and your target number is right where you want it, you don’t push things. (As it is, I don’t think the Fed is targeting unit labor costs, and I think there’s actually a significant chance of an increase this afternoon, contrary to the current consensus.)

You might want to look more closely at the second quarter figure. One reason it was so high is that productivity growth was slow. In general, one wouldn’t expect that weak productivity growth in a particular quarter means we should expect weak productivity growth in the future. Applying my smoother to productivity growth, I get a rate of 2.7%, compared to the 1.1% reported for the second quarter. So if we use trend productivity growth instead of the quarterly observation, that shaves 1.6 percentage points off that ugly 4% and leaves us with 2.4%, a much less alarming number.

The other side of the picture is compensation growth. Nominal hourly compensation grew quite rapidly (5.1% annual rate) in the second quarter. Does anyone expect it to keep growing at that rate? I certainly don’t, not after the recent huge drop in help wanted advertising.