Wage Inflation

The equation of exchange. You know it:

Central to monetarism is the equation MV = PQ. M is the money supply; V is velocity -- the number of times per year the average dollar is spent; P is prices of goods and services; and Q is quantity of goods and services.

Hey, only P and Q today. Price and quantity. P is the price level. Q is the quantity of output. If Q by itself is Real GDP, then P times Q is Nominal GDP.

But that doesn't only work for GDP. It works for things with varying prices: To convert from "nominal" to "real" you divide by price. To convert from "real" to "nominal" you multiply by price. To see the prices, you divide "nominal" by "real". Mind your P's and Q's.

I was looking at my list of FRED data on productivity, and suddenly realized it includes both the real and nominal versions of "compensation per hour".

I could divide the nominal by the real and see wage inflation. That might be interesting.

I'm leaving output out of it. I'm not considering productivity here, only varying wages. I'm using business sector data, nominal divided by real compensation per hour. I show it in blue. For comparison, in red I'm showing the CPI. Indexing make the two series equal at the start:

Graph #1: Wage Inflation (blue) and the CPI (red), both indexed to 1948-08-01

Red and blue run tight together until around 1980. Since the 1980s, then, wages fall behind prices.

I thought that was pretty interesting. Since around 1980, wages don't keep up with prices. Maybe that's why the Fed has had such a hard time reaching its 2% inflation target. And maybe it's why wage earners have such hard times.

Wondering by how much the wages have fallen behind, I rearranged this data to show wage inflation relative to CPI inflation. What I found was pretty surprising:

Graph #2: Wage Inflation as a Percent of Consumer Price Inflation

Again, indexed to make them equal at the start.

The blue line runs at 100.0% consistently from 1947Q1 to 1977Q4, then suddenly falls beginning in 1978Q1. That's pretty weird. It almost looks like they were using business sector compensation costs to figure the CPI, and then suddenly they weren't.

// See also: Kitov's warning