Sunday, September 6, 2015

Labor Market Slack And Wage Growth

Wages tend to rise as the unemployment rate falls.  Therefore, wage growth is one signal that the Fed uses to determine the state of the labor market.  However, since wage growth is also linked to productivity growth, slow growth in wages may reflect slow productivity growth rather than a weak labor market.  Two Fed officials ponder this dilemma in this article.  One argues that wage growth has been equal to productivity growth in the last few years, and uses that relationship to conclude that their is no slack in the labor market.  The Fed Chairperson hedges a bit and suggests that slow growth in productivity may be one of the factors that have contributed to slow wage growth but that there still may be some slack in the labor market. 

This discussion among Fed officials is interesting but it leaves a more important question unanswered.  The relationship between productivity growth and wage growth is shown in the following graph.  Productivity growth has exceeded wage growth growth substantially over the last 35 years.  The relationship between productivity growth and wage growth no longer exists.  Most of the growth in productivity has gone elsewhere. 

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