Wages and Panic Buttons (http://www.nytimes.com/yr/mo/day/oped/03tyso.html) (fwd)

jf noonan jfn1 at msc.com
Tue Aug 3 13:18:01 PDT 1999


Here's a nice little content free piece. (I think she's been taking those "say less with more words" lessons from Chairman Al.)

--

Joseph Noonan jfn1 at msc.com

---------- Forwarded message ----------

August 3, 1999

Wages and Panic Buttons

By LAURA D'ANDREA TYSON

Financial markets reacted with alarm last week to

an unexpectedly large increase in the

compensation of the American work force. For

Americans who work for a living and also invest

in financial markets, this reaction may seem

perplexing and even perverse.

Doesn't a strong economy mean higher take-home

pay for American workers as well as higher

profitability for American companies and those

who invest in them? Must there be a tradeoff

between the well-being of Americans as workers

and the well-being of the same Americans as

investors?

Inflation is the link between the health of

financial markets and the health of labor

markets. Wages are the largest component of

family income, but they are also the largest

component of production costs. When worker pay

grows faster than worker productivity, costs

rise, profits are squeezed, and prices start to

increase more quickly.

Higher prices in turn mean higher interest rates,

as lenders insist on higher returns to protect

against future inflation and as the Federal

Reserve acts to quell inflation by raising

short-term interest rates. And higher interest

rates mean lower prices for financial assets like

stocks and bonds. The implication of this chain

of simple economic logic is clear: inflation is a

common threat to Americans as workers and as

investors.

Fear of a surge in inflation caused financial

markets to swoon after Government statistics

showed last week that the employment cost index

was up an unexpected 1.1 percent for the quarter.

The index is generally considered to be the best

measure of what's happening to overall

compensation, which encompasses both wages and

health benefits and pensions.

So the markets' anxiety may have been

understandable. But it was also excessive.

First, as anyone who works with economic

statistics knows, a single quarter's estimate

does not a trend make. Although the increase in

the employment cost index in the second quarter

of this year was the largest since 1991, it

followed two quarters of unexpectedly small

increases. Over the last year, the index climbed

by about 3.5 percent, slightly slower than the

year before.

Second, much of this recent increase reflected

commissions and performance-related pay in

financial services jobs -- one-time increases

rather than permanent additions to compensation.

Third and most important, so long as worker

productivity continues to rise at about 2 percent

a year, American companies can afford to pay

their workers 3.5 to 4 percent more per year

without increasing their prices faster than the

current inflation rate of about 2 percent.

Why, then, are financial markets so skittish?

There are several factors at work that have

nothing to do with American workers' pay.

The global economy is heating up as Europe, Japan

and several emerging markets recover from

recessions. This is causing commodity prices to

rebound, increasing the prices of things like

energy, which are also important ingredients of

production costs.

In addition, greater competition for capital in

the rest of the world is curbing foreign appetite

for American financial assets, driving the

dollar's value down in recent weeks. This is a

source of anxiety because the dollar's

appreciation has shaved at least half a percent

off our annual inflation rate during the last few

years.

In short, there is little evidence that labor

costs are rising, despite tight labor markets,

but there is mounting evidence that other factors

have again shifted the balance of risks facing

the American economy toward inflation.

Moreover, the chairman of the Federal Reserve,

Alan Greenspan, has signaled that the Fed is

poised to raise short-term interest rates again

this year if necessary to pre-empt an increase in

inflationary pressure. This is hardly a soothing

message for equity markets, which according to

standard models are somewhat overvalued and

therefore vulnerable to correction.

Still, all this skittishness should not obscure

the fact that tight labor markets have been a

real boon for the American economy. After years

of stagnation, wages and family incomes for the

majority of Americans are finally growing; after

decades of widening, income inequality is finally

narrowing, and unemployment rates for members of

racial minorities and high-school dropouts have

hit record lows.

The challenge for Washington in the coming months

will be how to navigate this expansion along a

road marred by potholes of inflationary risk. The

good news is that with inflation and interest

rates still low, productivity growth strong and

technological change fueling investment in new

production capacity, there is no need for the Fed

to slam on the breaks. A little judicious slowing

at the right time -- that is, a small adjustment

or two in rates if conditions warrant -- should

do the trick, so long as those nervous financial

markets do not cause us to lose sight of the

road.

Laura D'Andrea Tyson, dean of the Haas School of

Business at the University of California at

Berkeley, was chairwoman of the White House

Council of Economic Advisers and the National

Economic Council in the first Clinton

Administration.



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