Yellen earlier this year:
“We will be looking at wage growth” as a signal of inflation though “I wouldn’t say either that that is a precondition to raising rates.” [Translation: I´ll raise them anyhow!]
Results over two decades for the general theme: Are wages useful in forecasting inflation?
Researchers have extensively studied how wage data might help predict future price inflation. The overall conclusion of the literature is that wages generally provide less valuable insight into future prices than some other indicators. In fact, models that do not incorporate wages often result in superior inflation forecasts.
The cost-push view of the inflation process that is implicit in the expectations augmented Phillips curve model assigns a key role to wage growth in determining inflation. In this article, I evaluate this role by investigating empirically both the presence and stability of the feedback between wage growth and inflation during the U.S. postwar period, 1952Q1 to 1999Q2. The results indicate that wage growth does help predict future inflation over the full sample period considered here.
However, this finding is very fragile, and it appears in the full sample because the estimation period includes the subperiod 1966Q1 to 1983Q4 during which inflation steadily accelerated.
Wage growth does not help predict inflation in two other subperiods, 1953Q1 to 1965Q4 and 1984Q1 to 1999Q2, during which inflation remained low to moderate.
In contrast, inflation always helps predict wage growth, a finding that is both quantitatively significant and stable across subperiods. These results thus do not support the view that wage growth has been an independent source of inflation in the U.S. economy.
Many analysts have heralded the slow growth of unit labor costs during recent years as a harbinger of continued low inflation. In this article, we investigate the usefulness of labor costs as a predictor of inflation. Earlier studies have focused on in-sample causality tests. Our in-sample causality tests indicate that, during the pre-1980 period, wage growth did have information content for future core inflation (CPIC) but not overall CPI inflation. During the post- 1980 period, however, this information content has disappeared.
Additionally, we find that the evidence of inflation causing wage growth is quite robust across samples.
In contrast with earlier studies, we also investigate out-of-sample forecasts of inflation using labor costs in an error-correction model. Out-of-sample forecasts offer the ultimate test of whether wages help predict future inflation. For recent years, the out-of-sample forecasting exercises offer no evidence that wage growth contributes to any reduction in forecast errors compared with univariate autoregressive models of inflation. Therefore, when assessing future inflation developments, these results suggest that policymakers and analysts should put little weight on recent wage trends.