Saturday, September 22, 2007

Target Unit Labor Costs

Last year (here and here, with related posts here, here, here, here, here, here, and here – or just read the August 2006 archives and my post from yesterday) I suggested that the Fed should target unit labor costs. Upon additional thought, I still think so. I won’t go through the whole argument again, but I want to note a few important points:

  1. I’m referring to targeting a forecast of labor costs (using a “price rule” that would correct for the failures of earlier forecasts), not trying to react to every wiggle in the reported series, which is reported with a lag, quite volatile and subject sometimes to fairly dramatic revisions. The idea is for the Fed to have a long-run stable growth rate of unit labor costs as its ultimate objective, upon which it could be judged after several years of hindsight, when the final revisions come in and the trends become clear.

  2. The main purpose of this approach is to have a simple and easily understood (by the market) answer to the question of how to react to supply shocks. The appropriate response to supply shocks is a matter of great controversy in macroeconomics: should a central bank accommodate supply shocks and let the inflation rate rise temporarily in order to avoid a recession or a slowing of growth (or a boom, in the case of a favorable supply shock), or should it lean heavily against the inflationary impact (or the deflationary impact) of supply shocks in order to pursue an unchanged target inflation rate? The labor cost target settles the question: if the shock is to domestic productivity or to the labor market, then lean against the inflationary impact; if the shock is entirely outside the domestic labor market and production process, then accommodate (except to the extent that you expect the shock to have indirect effects on productivity and the labor market, such as might arise, for example, from sticky real wages).

  3. If the Fed is going to adopt such a policy, now is the time to announce it – or rather, to let the idea of prioritizing unit labor costs find its way into the speeches of Fed officials, since that’s the way the Fed operates. All indications today are that we are heading directly into an unfavorable import price shock. How will the Fed react? The market shouldn’t have to make random guesses. Moreover, there is great uncertainty about the intensity of the shock, and to some extent, the direction (because oil is something of a wild card and could have a big drop in price just as easily as a big increase). We want to know now what reactions to expect when these uncertainties are resolved.

  4. When today’s incipient shocks are fully realized, Fed credibility is going to be a big issue, especially with a relatively short-tenured Chairman and given the market’s response to this week’s Fed action. In the case of a severe adverse shock, if the Fed hasn’t specified in advance how it intends to react, it will face a choice between recession and loss of credibility. That’s not a situation that anyone will enjoy.

  5. As the following updated chart indicates, the Fed can make a pretty good case that it has already been targeting unit labor costs since the early 1990s. (The old talk about a preferred inflation rate between 1% and 2% rings a bit hollow – in addition to being, in my opinion, a less than optimal target range for inflation. But unit labor costs have stayed pretty nicely in that range – although, in my opinion, it’s a less than optimal target for unit labor costs as well, and I would hope the Fed would go maybe for something like 2%.)


From the chart, it looks like we need a slowing of unit labor costs now to continue keeping in line with the target. But given the recent weakness in the labor market and simultaneous recovery in output growth, as well as various factors suggesting a high risk of recession, I think the central tendency of the Fed’s forecasts will be for slower labor cost growth anyhow. All in all, labor costs are still very close to the presumed target, so the priority at this point should be for maintaining stable growth rather than attacking a bulge in labor costs. (And if the Fed were to do as I prefer, and raise the target to 2%, there wouldn’t be any question.)

Labels: , , , , , , , ,

25 Comments:

Anonymous Anonymous said...

knzn — Maybe you can clear up a long-time conundrum (misunderstanding) of mine. Unit labor costs are labor-cost per unit output, right? But then how can they grow without bound, at any trend rate? One would expect a per-unit cost to stabilize, or oscillate, or grow asymptotically more slowly, otherwise you'd get more than $1 labor cost per unit, no? Yet unit labor cost series seem, as you show, to consistently grow, even at trend exponential rates? I must be missing something. Can you help?

Sat Sep 22, 05:10:00 PM EDT  
Blogger knzn said...

Unit labor costs (at least the way I'm using the term here, which I think is also how the BLS uses the term) are nominal labor cost per real unit of output.

(The "unit" is arbitrary and depends on the basing year, and the concept of "real" output is subject to the usual conceptual problem that you can't truly add apples and oranges, so you have to change the relative values each period and chain them together; at least I think that's what the BEA does to get the real output series that the BLS uses to compute unit labor costs.)

Since it's a ratio of a nominal to a "real" variable, unit labor cost goes up, broadly speaking, with the general price level, but it can diverge significantly even in the 20-year time frame in my chart. I have several posts in July and August of 2006 dealing with (or at least asking) the question of why this divergence happened. It is roughly equivalent to saying (in some sense which needs to be defined) that labor's share of output went down.

Sat Sep 22, 05:45:00 PM EDT  
Anonymous Anonymous said...

knzn — Thanks. That's a big help. So it's no problem then that the numerator gets bigger than the denominator, and the absolute value of the statistic is utterly meaningless, only changes matter. Trying to understand, reported unit labor costs would almost always increase, but the question of whether this represents an increase in cost-per-unit in an apples to apples sense would hinge upon whether the statistic increased more or less than the inflation measure used to deflate the denominator. Is there a good reason for not just deflating the numerator to get a "real" to "real" measure? That way, you'd broadly expect unit labor costs to be constant, and "divergences" would be quite obvious.

Anyway, thank you for the response. This really has puzzled me for a long time. I'm going to go reread your post now, with a much better sense of what you're talking about....

Sun Sep 23, 05:04:00 AM EDT  
Anonymous Anonymous said...

knzn — So, looking back at your post (and the informative chart), it seems like to the degree the Fed has implicitly targeted unit labor costs, it has targeted it a far too low level! If the GDP deflator trends at 2%, and ULC at 1.5%, that implies that labor's share of GDP is in exponential decline, no? Absent central banks, one might argue that this is a natural effect of technological change or somesuch. (I would not make that argument, but it's an obvious suggestion.) But in a world where capital is unevenly distributed and the wealthy reinvest greater proportions of earnings (so ceteris paribus, rents from capital concentrate), wouldn't a Say's-Law-skeptical central bank want to target ULC at least at the level of the GDP deflator, that is, keep labor's share of output about constant to prevent negative demand shocks and maintain sustainable full employment? Targeting labor's share of output to asymptotically decline towards zero strikes me as troubling, both from a macroeconomic stability perspective, and as a normative matter.

Sun Sep 23, 05:27:00 AM EDT  
Blogger David Beckworth said...

knzn--very interesting proposal. A potential implication of your proposal is that productivity-driven or benign deflationary pressures should be allowed. I am completely sympathetic to this idea.

Your proposal is not that different than the labor productivity norm rule proposed by George Selgin. I wrote about the productivity norm rule here.

Sun Sep 23, 10:57:00 AM EDT  
Blogger knzn said...

Steve, you seem to be taking price inflation as a given. My view is that price inflation depends (or would depend) on how the Fed chooses to target unit labor costs. (As the length of the time frame under consideration increases, I think all economists views will converge to mine in that respect.) So, if the Fed had targeted unit labor costs at 2% instead of 1.5%, then the GDP deflator would have risen by maybe 2.5% instead of 2%.

OK, my last statement makes the stronger (and more controversial) assumption that the Fed has little ability to influence distribution at all. I know there are many who argue that the timing of Fed actions can influence distribution. But I would say that a sufficiently foresightful approach to targeting labor costs would not imply anything about the timing of Fed actions. To the extent that such an actual policy does imply something about the timing, it's not clear to me that it is bad for labor.

See also my comment on Mark Thoma's post, as well as the second link to last year in this post.

Sun Sep 23, 12:21:00 PM EDT  
Anonymous Anonymous said...

knzn — I see your point. If you believe that the labor share of income is independent of monetary policy, then declining (or who knows, maybe someday increasing) share would happen anyway. You suggest a world in which nominal wage growth would be fixed, and real returns to labor would be a function of market-determined broad inflation. In good years for labor, the price of other stuff would decline relative to labor. In bad years (like most years, it seems) inflation would eat away at labor's targeted nominal gains. But the price of labor relative to other stuff would be outside the ambit of the central bank. This is a coherent and reasonable view, I think.

Reading the comments to the Thoma post, there's a lot of skepticism, and I'd share that skepticism, but that has to do with a cynicism about the distributional and allocational effects of central bank behavior that you don't seem to share. If you believe (as, alas, I do) that the US central bank has in fact strongly influenced labor's share of income, and that their institutional bias is to do so in a way that harms labor, then your theoretically elegant proposal seems less appealing.

To clarify a bit, I think the US central bank has harmed labor's share of output in at least two ways: By diminishing volatility in asset prices and thereby increasing long-term returns to capital (consider geometric means) — sometimes doing so by explicitly leaning against labor — the central bank arithmetically diminishes labor's share, if you imagine a stable sustainable economic growth rate and alternative paths to achieving it. (One could argue that growth paths with low asset-price volatility so outstrips alternatives that labor benefits from this asset price management, but I don't think the data supports that view.)

A second means by which the US central bank has harmed labor is outside of monetary policy, in its role as regulator of the financial system. The Fed has played an important part in enabling the trade deficit, passively by permitting banks to aggressively originate, securitize, and sell debt, and actively by encouraging a culture of borrowing to fund current consumption against price-stabilized assets. Although workers as consumers may have benefited from these arrangements, as wage-earners they have clearly been hurt. The Fed could have leaned against a borrow-for-current-consumption economy. Instead it enthusiastically cheered it, reflective, I think, of institutional biases that favor capital and its member banks.

All this is a digression, though. In a theoretical way, I think your suggestion is rather elegant, now that I understand it. I simply distrust the Fed too much to be very enthusiastic.

Sun Sep 23, 01:59:00 PM EDT  
Blogger knzn said...

I'll have to think a bit more about the two ways in which you suggest that the Fed harms labor's share. But clearly neither of them depends (at least, in any obvious way) on whether the Fed is targeting labor costs as opposed to prices. In general, I don't think there is any clear way in which targeting labor costs would be worse for labor than targeting prices, even if the Fed has a bias against labor (since the bias will be there in any case).

One point that I think I need to stress is that targeting labor costs doesn't necessarily mean reacting directly to labor costs, except over a long time horizon. The labor cost data aren't very reliable over a short horizon anyhow, and I think business cycle considerations would actually suggest that it would be a bad idea to tighten during the part of the cycle when labor costs are likely to be rising most quickly. I think the Fed should anticipate the cyclical behavior of labor costs in its forecasts and then tighten or loosen depending on how labor costs behave relative to their anticipated cyclical behavior.

Sun Sep 23, 07:24:00 PM EDT  
Anonymous Anonymous said...

knzn — No argument. Targeting unit labor costs directly would not be worse in any substantive sense than what the Fed's doing now . The"optics" would be a bit rougher, though, as "making sure workers don't get paid too much" is a more troubling sound-bite than "keeping prices low for consumers". But that's a feature, not a bug, from my perspective, as I'd like to see more populist scrutiny of Fed behavior (not to end central bank independence, but to ensure the central bank merits that independence by pursuing broad-based aims in a technocratic way instead of the narrow aims of well-connected constituencies).

Anyway, thanks for a thought-provoking post. I enjoyed the conversation. And thanks again very much for helping me understand why BLS labor costs almost always rise, even as labor's share decreases. I've stayed up nights scratching my head over that one, and even several hours of googling once-upon-a-time failed to set me straight.

Sun Sep 23, 11:42:00 PM EDT  
Anonymous Anonymous said...

Hello, I like your blog. It is rather interesting, that is why I decided to browse the net and on this great site www.pisseconsumer.com I learned about this company a little more. Target is an American retail company. Target is the fifth largest retailer in the US in terms of sales. Target specializes in retail selling a wide range of products: clothes, footwear, home decor, furniture, garden products, jewelry, beauty products, electronics, pet products, and sporting goods.

Tue Aug 05, 06:06:00 AM EDT  
Anonymous Anonymous said...

I like your blog . They are really great. Ermunterung ++ .please pay a return visit to my blog .thank you.
ameblo.jp/iblog99/
iblog99.blog.shinobi.jp
webthink.blog126.fc2.com/

Sun Jun 21, 08:50:00 PM EDT  
Anonymous Anonymous said...

フランチャイズ
育毛剤
育毛剤
グループウェア
幼児教室
電話占い
探偵
薬剤師 求人

Fri Jul 10, 04:03:00 AM EDT  
Anonymous Anonymous said...

We possess professional anime cosplay costumes with an abundant designing strength. High quality Black Butler Cosplay and Anime Cosplay Costume On Sale. You can dress naruto cosplay up for Cosplay show. Cheap Cosplay will feature an array of gently used Halloween Cosplay Costumes and accessories in adult and children’s sizes. Individuals interested in donating Wholesale Costume can drop them off. Wright Elementary through the day of the sale. A collection of Japanese School Uniform,cosplay naruto,Final Fantasy Cosplay,Bleach Cosplay,Kingdom Hearts Cosplay is hot sale now.

Wed Sep 30, 02:18:00 AM EDT  
Anonymous polo jackets said...

I like your blog, I think it's excellent, and the articles are meaningful.
Would you like wearing cheap polo shirt? Do you want to be a fashion chaser? Follow me and you can chase the most popular white polo shirts. it can help you increase your attraction, you will be the focus wherever you go only if you wear polo clothes.
would you want to be more attractive? If your answer is "Yes", you can wear best-seller columbia jacket, you really need a pair of white ralph lauren jacket. They can make you become the attactive person.
Recently, I am always wanting to buy high quality, low price prince tennis rackets, and I find many places, where sells perfect tennis racket. In order to play the game and search the place where can buy the head tennis racket, and finally, I find thistennis shop. You can buy what you want in this store online.
head tennis racquet
babolat racquet
wilson tennis racquet
prince accessories
cheap head tennis racquets
wilson tennis racquets
superior babolat tennis racquets
polo shirt women
polo shirts men's
cheap polo jacket
high quality columbia jacket
claasic north face jacket
perfect spyder jacket
ralph Lauren shirts
polo A&F shirts
polo shirt
north face jackets
polo short sleeves shirt
ralph lauren polo long sleeves shirts

Mon Oct 12, 08:41:00 AM EDT  
Blogger 月月 said...

jordan 4
jordan 5
jordan 6
jordan 7
jordan 8
jordan 9
jordan 10
jordan 11

Wed Mar 17, 07:13:00 AM EDT  
Blogger aai333 said...

Nice article written by you
Nice cheap Nike dunk
articlediscount nike dunk
written nike dunk
bydiscount nike shoes
youcheap nike shoes
Christian Louboutin boots
Chloe outlet
cheap Chloe
discount Chloe
newest Chloe
Chloe bags 2010
Chloe totes
bape shoes
bape clothing
discount bape shoes
cheap bape shoes
bape jackets
wholesale ed hardy
ed hardy wholesale
discount ed hardy
Babyliss
Benefit GHD
MBT boots
MBT shoes in fashion
cheap mbt shoes sale
discount mbt outlet 2010
MBT Walking Shoes

Wed Apr 21, 10:06:00 PM EDT  
Blogger ai said...

cheap ralph Lauren polo shirts
discount ralph lauren outlet
lacoste polo
polo shirt 2010
raplh lauren

Wed Apr 21, 10:17:00 PM EDT  
Blogger Unknown said...

Teenagers in a track adidas tennis shoes can go through shoes rate discount adidas sneakers teenage runner well knows that newest adidas shoes 2010 to wear the right shoes discount moncler outlet any cross country among world cheap adidas shoes especially important to the sportsman wholesale adidas shoes a young person growing up adidas shoes outlet Not only do they want to discount moncler t-shirt grow out of their shoes cheap jordan shoes but shape of their feet changes new jordan shoes which means every time we new jordan shoes the time comes to get air jordan 2010 a new pair of shoes eveyone discount jordan shoes a good choice to get jumpman23 it with a high material Jordan ajf shoes that breathes easily on random Newest Timberland shoes 2010 They should be extended runs cheap Nike shox shoes give enough support to athlets discount brand shoes especially around the ankles area cheap Nike Dunk shoes to avoid injury your ankles AIR MAX shoes outlet when you make your trip 2010 New GHD something in store possible fit Benefit GHD his is also the way to

Thu Apr 22, 08:47:00 AM EDT  
Anonymous Anonymous said...

|Jimmy Choo Patent leather wedge sandals
|Jimmy Choo Patent leather wedge sandals
|Jimmy Choo Phoenix espadrille wedges
Christian Louboutin Paquita 120 satin sandals

Wed Sep 22, 11:46:00 AM EDT  
Blogger alice said...

Helo, your blog is really good, I like it very much!By the way, if you like nike chaussures tn you can come here to have a look!
ugg outlet
uggs outlet
ugg classic
ugg classic boots
ugg online
ugg boots
cheap ugg boots
discount ugg boots
australia ugg boots
wholesale ugg boots
sheepskin ugg boots
ugg boots 5815
ugg boots size 9
ugg snow boots
womens ugg boots
classic tall ugg boots
short ugg boots
new ugg boots
winter ugg boots
ugg boots outlet

Tue Feb 22, 10:12:00 PM EST  
Anonymous Your Escort Agency said...

Your Escort Agency offers exclusive and most beautiful London escort girls of various nationalities.

Sat Aug 27, 04:29:00 AM EDT  
Anonymous London escorts said...

Bestescort4U agency provids best London escorts companionship in the UK.

Wed Oct 19, 03:05:00 PM EDT  
Anonymous Escorts London said...

Hot - Collection is a honest and confidential London escort agency which provides genuine London escorts girls for gentlemen of taste.

Thu Nov 03, 01:59:00 PM EDT  
Blogger sell nike air max shoes said...

Welcome to www.fashionablepumps.com We invite you to explore our complete collection of christian louboutin Shoes which include christian louboutin, christian louboutin sale,christian louboutin Shoes , Christian Louboutin Pumps,Christian Louboutin Sandals, louboutins shoes,Our luxury Christian Louboutin using only the highest quality materials.We bring you the finest quality, at the lowest prices.

christian louboutin,louboutin,louboutins,louboutin sale,christian shoes,christian louboutin shoe,christian louboutin sale,Christian louboutin Pumps,louboutin shoes,christian louboutins,Christian louboutin shoe,shoes Christian louboutin,Christian louboutins shoes,Christian louboutins sales,Jimmy choo,Jimmy shoes,Jimmy choo shoes,Jimmy choo Shoe

Wed Nov 09, 02:27:00 AM EST  
Anonymous Anonymous said...

Hey knzn,

I don't know if you still check in on this blog, but I was wondering - what's the distinction, end-point wise, between this proposal and Thompson's 1982 "labor standard" proposal, given that both target a relatively fixed wage price? Is the distinction agent-based, where this proposal could be implemented by the Fed alone, whereas a full-blown "labor standard" would require a whole-of-government approach, or is there something else I'm missing? Thanks!

Fri Aug 18, 11:46:00 PM EDT  

Post a Comment

<< Home