South-Western College Publishing - Economics  
Spell Surprise with an ECI
Subject Inflation
Topic Employment, Unemployment, and Inflation
Key Words Inflation, Unemployment, Productivity
News Story

When labor demand increases faster than labor supply, labor markets tighten and labor costs are supposed to increase. U.S. labor markets are tight with the unemployment rate at or near 29-year lows. The Labor Department, however, has just reported that labor costs, as measured by the Employment Cost Index (ECI), rose just .4 percent last quarter, the smallest gain since 1982. For the past 12 months, the ECI rose 3 percent compared with 3.7 percent for the year ending last September. During this same period, wages and salaries were up 3.3 percent and the cost of benefits increased 2.3 percent.

Even though the past 12 months' 3 percent increase in labor costs was low compared with recent years, inflation-adjusted gains are near their 30 year high because inflation was only 1.7 percent over the same period. Because wages are not rising rapidly, there is less pressure on employers to raise prices. With little inflationary pressure, the Federal Reserve is unlikely to raise interest rates even if the economy continues to grow faster than Fed officials have forecasted.

Economists believe that because of increased competition from abroad, companies are having a difficult time passing along price increases. As a result, firms are trying to hold the line on compensation gains. Small increases in labor costs coupled with strong productivity gains have allowed firms to maintain or even increase profit margins.

Many analysts had been expecting substantially higher ECI figures. Their forecasts were based upon the combination of strong growth and a 30-year low unemployment rate. This surprising result has caused some economists to question the validity of the ECI figures. The increase in the ECI, they argue, tracks the increase in hourly average earnings, the other measure of workers' compensation, fairly closely. Hourly earnings increased .8 percent this past quarter - almost double the ECI.

(Updated June 1, 1999)

Questions
1. What is the Employment Cost Index (ECI)? What does it measure?
2. Why would analysts and policymakers pay close attention to the ECI?
3. An economist argues that workers are not asking for very high wage increases because their inflation-adjusted wage gains are at a 30-year high. What is the difference between a nominal wage increase and a real wage increase? Why might workers be more concerned with real increases than with nominal ones?
Source John M. Berry, "Labor Costs Rise 0.4% in Quarter", The Washington Post, April 30, 1999.

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