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