NCPA - National Center for Policy Analysis

Labor Costs And Inflation

October 20, 1997

Increased worker compensation among service firms that are labor-cost sensitive may have a greater effect on price inflation than pay increases in similar goods-producing industries, according to a study from the Federal Reserve Bank of New York.

Economist David A. Brauer looked at how pay increases in different sectors affected related product prices. He focused on two classes of items in the consumer price index (CPI).

  • One was labor-cost-sensitive goods -- such as cars, apparel and home furnishings -- which account for 19 percent of the CPI.
  • The other was labor-cost-sensitive services -- including such items as restaurant meals, auto insurance, air fares and personal services -- which make up 23 percent of the CPI.
  • Looking at the period from 1983 to mid-1997, Brauer found no evidence that changes in compensation in goods-producing industries preceded changes in prices of labor-cost-sensitive goods.
  • In services, however, he found evidence that increases in pay do result in more rapid inflation -- both directly via the prices of labor-cost-sensitive services and indirectly as the costs of such services influence other components of the CPI.

He estimates that a one-percentage-point rise in the growth rate of hourly compensation in services raises overall inflation by about two-tenths of a percentage point within a year.

Source: Gene Koretz, "Do Labor Costs Spark Inflation?" Business Week, October 20, 1997.

 

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