Labor costs and inflation - there is no link

One of the key data focuses concerning the lift-off of rates by the Fed concerns labor costs and inflation.  Many believe that the Fed should not or will not raise rates until the data some upward moment in wages regardless of the unemployment rate. When wages start to increase, there will be a pass-through to inflation which will be the signal that it is time to raise rates. If wages have not increases, there is still slack in the economy regardless of the the unemployment rate. The argument is that the labor market is still too weak. With low labor participation, the unemployment rate is not a good signal because more part-time or potential labor on the sidelines will be able to take full-time jobs and keep wages down. Don't look at unemployment, look at wages and the passthrough as the key to action.

The wage pass-through argument has become a key catalyst and focus for Fed action. Well, the latest research from the Fed states that there is no link between labor costs and inflation. The new paper "The Passthrough of Labor Costs to Price Inflation" by E. Geneva and J. Rudd.  provides some interesting insights on the link or the lack of link for the periods outside of the 1970's. This research is a theoretical piece on the statistical relationship between labor costs and inflation over different time periods. This work adds to the confusion on how the Fed should act or how we should think they will act. On the one hand, the Fed should not base their action on a relationship that may not exist. Of course, the data could also suggest that labor markets are weak and have been weak for a long time and the Fed should continue to help jump start the economy.

We don't have a strong opinion on the policy arguments. However, we find this work important because expectations are being formed on what may be a faulty premise.