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Snapshot for May 26, 2004.
Rising inflation due to profit margins and energy, not labor costs
Consumer prices have risen by 2.3% in the last 12 months and at a 3.9% rate in the last three months according to the Consumer Price Index (CPI). The recent pickup in inflation has brought cries for the Federal Reserve to raise interest rates and complaints that the Fed is “behind the curve” in curbing inflation. Ironically, for much of the last year, the Federal Reserve was justifiably more concerned that inflation would get too low rather than get too high. Fed Chairman Greenspan has appropriately emphasized that labor costs make up more than 60% of the costs of production and that they do not present an inflationary problem. The current inflation can instead be traced to increased U.S. profit margins and prices for commodities such as oil.
In fact, labor costs adjusted for productivity continue to put downward pressure on inflation. Unit labor costs (ULC) are the cost of labor input required to produce one unit of output. As Figure 1 indicates, ULC rose in tandem with the CPI during the periods of sharply rising inflation in the late 1960s, the early 1970s, and the late 1970s, and even during the more modest increases of inflation in the late 1980s and the late 1990s. Nothing of the sort is happening today. In the last year, labor compensation increased by a nominal 4%* but because productivity grew by 5.4%, ULC declined by 1.3%. Productivity gains slowed to 3.5% in the first quarter of 2004, but that still left ULC rising at a modest 0.5% growth rate. ULC contributed to the declining inflation rate of 2003, and inflation would be 0.5% today if not for other factors.
The CPI has risen 3% faster than ULC for a record nine consecutive quarters. As Figure 2 shows, the gap has been that wide many times before, but never for very long. The longest stretch in the past lasted for four quarters across 1983 and 1984.
Two factors account for the unprecedented gap in the CPI and ULC. First, profit margins have been rising rapidly. Unit profits in the nonfinancial corporate sector have risen by 27.1% in the last four quarters and by 20.6% in the prior four quarters. Second, the prices of oil and other commodities have been rising rapidly in the last year or so. The energy component of the CPI has risen by 5.6% in the last 12 months and at a 16.0% rate in the last three months alone.
Higher interest rates may slow the economy and curb the growth of labor compensation, but it is not clear that they will have much effect on the real sources of today’s inflation: increasing U.S. profit margins and world commodity prices.
* Hourly wage and salary gains have been running about half the rate of total compensation, but employer contributions for medical premiums and defined benefit pensions have been rising much faster.
This Snapshot was written by EPI Research Director Lee Price.