Pay Envelopes Hold the Answer to What Drives Prices Up
Anytime the consumer price index goes up, as the government reported it did last month, some financial analysts immediately worry that the Federal Reserve will respond by boosting short-term interest rates.</br></br>In fact, many Fed officials, including Chairman Alan Greenspan, usually pay more attention to what is happening to costs that could push inflation up in the future - than to recent changes in prices.</br></br>The numbers Fed officials monitor most closely are those on labor costs, because for most businesses they are the biggest cost item by far. For the average business, wages paid to employees and the cost of fringe benefits represent more than 70 percent of all expenses. The labor statistic that economists follow most closely is "unit labor costs," which tracks the labor cost of each unit produced, and thus reflects any labor-saving productivity gains.</br></br>The chart at right shows how closely consumer price inflation has tracked changes in unit labor costs since 1980. It also indicates why so many analysts think inflation will remain subdued for some time to come: Unit labor costs are low and give no sign of accelerating.</br></br>In the 12 months that ended in September, businesses other than farms increased worker compensation an average of 3.2 percent, according to the Labor Department. But productivity gains - increases in the amount of goods and services produced for each hour worked - of 1.4 percent meant that firms' unit labor costs rose only 1.8 percent.