US Economic Update: September 2016

Despite inflation remaining stubbornly below the Fed’s 2% goal, lower unemployment can still be expected to generate price pressures.

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Inflation, Unemployment and Wages in the US

Despite inflation remaining stubbornly below the Fed’s 2% goal, lower unemployment can still be expected to generate price pressures. The short-term link between wages and inflation is even less clear but, over time, strong labour costs are associated with higher inflation and also provide additional evidence that the labour market has recovered.

Many advanced economies continued to face low inflation, even in the face of continuing efforts by central banks to inflate their economies through unconventional monetary policy.

Forecasts of higher inflation in these economies rely on the view that improving labour markets will put upwards pressure on prices.

This view is endorsed by the Fed Chair, Janet Yellen who in a September 2015 speech stated “Economic theory suggests, and empirical analysis confirms, that such deviations of inflation from trend depend partly on the intensity of resource utilization in the economy–as approximated, for example, by the gap between the actual unemployment rate and its so-called natural rate…”. However, another Fed member, Lael Brainard, has cautioned against relying on this past relationship.

Looking at the US we find that the relationship between the labour market and inflation is still working, although it is not that precise and other factors are also important. The short-term link from higher wages to inflation is less clear, but sustained higher wages growth – or more precisely higher unit labour costs (which adjust for productivity) – would provide added confirmation that the labour market has improved and that any pick-up in inflation would be sustained.

For further details please see the attached document

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