(WP 2010-10) Assessing the Predictive Power of Labor-Market Indicators of Inflation

This paper examines two different measures of wages as predicators of prices in a vector error-correction framework using quarterly data for the U.S. for the period from 1947.Q1 through 2008.Q1. Based on cointegration and a series of exogeneity tests, it is found that: 1) there is a stable, long-run relationship between the Consumer Price Index (CPI) and the Personal Consumption Expenditure Deflator (PCED) on the one hand and unit labor costs (ULC) and average earnings per unit of output (AHE) on the other; 2) ULC is weakly exogenous for both price indices while the two price indices are weakly exogenous for AHE; 3) ULC is strongly exogenous for CPI but not for AHE; 4) ULC is super exogenous for CPI. Taken together, these findings lead to the conclusion that ULC is a reliable indicator of price inflation but productivity-adjusted hourly earnings is not. Thus monetary policymakers are justified in using information about the behavior of ULC in formulating policy actions for achieving the goal of price stability.*This research has been financed in part by a grant from the Center for Global and Economic Studies at Marquette University.**A short version of this paper is forthcoming in Applied Economics Letters.