Friday, February 06, 2009

Wage Deflation?

A reader asks me about this passage from today's Paul Krugman column:

We’re already closer to outright deflation than at any point since the Great Depression. In particular, the private sector is experiencing widespread wage cuts for the first time since the 1930s.
I agree with Paul that persistent deflation would be a problem (for reasons discussed in Chapter 11 of my intermediate macro textbook). But I am not convinced we are close as close to this precipice as Paul suggests. Stories of wage cuts are still anecdotal.

Let's look at the data. Here is an excerpt from today's employment report:

In January, average hourly earnings of production and nonsupervisory workers on private nonfarm payrolls rose by 5 cents, or 0.3 percent, seasonally adjusted. This followed gains of 7 cents in December and 6 cents in November. Over the past 12 months, average hourly earnings increased by 3.9 percent.
If we assume the normal 2 percent rate of productivity growth, 3.9 percent wage inflation is consistent with about 1.9 percent price inflation. So, at this point, widespread wage and price deflation seems more of a fear than a reality.

Here is the relevant graph of wage inflation:

Update: Paul Krugman responds that the employment cost index is a better measure of wages than is average hourly earnings. He might well be right about that. But note that his graph still shows positive wage growth, which does not suggest that "the private sector is experiencing widespread wage cuts." He also says he is actually worried "about deflation in a couple of years." So I think Paul and I now agree: As I said in my initial post, at this time, widespread wage deflation is more of a fear than a reality. If that is what Paul meant all along, then I was confused by his use of the present tense in passage I quoted above. I suppose it depends on what the meaning of the word "is" is.