I frequently argue that inflation is a highly misleading variable, and should be dropped from macroeconomic analysis. To replace it, we’d be better off looking at variables such as NGDP growth and nominal hourly wage rates.
If we cannot measure P tolerably well, then it sort of spoils the fun about talking about the real wage, the real money supply, or real GDP. I think that the consequence is that we shift all of the focus to:
— the average nominal wage rate, W
–total employment (or hours worked), N
The product of the two, WN, becomes aggregate demand (with NGDP an approximate indicator).
Aggregate supply determines the division between the two. For example suppose we have sticky nominal wages, with W depending on W* (what workers expected W to be, based on recent trends in nominal wages) and N (as employment gets closer to full employment, workers start to expect higher wages). We could have N affect the shape as well as the level of supply curve. That is, the effect of a change in N on wages could be low in a recession and higher near full employment.
From the Fred database, I have downloaded total compensation from the national income accounts (WN, in effect). And I downloaded total payroll employment from the establishment survey (N, in effect). The ratio of the two gives W. Some recent data on the percent change of these numbers.
| Year | WN percent change | W percent change |
|---|---|---|
| 2008 | 2.3 | 2.9 |
| 2009 | -3.6 | 0.8 |
| 2010 | 2.3 | 3.1 |
| 2011 | 3.9 | 2.7 |
| 2012 | 4.0 | 2.3 |
Over the last five years, the median value for the percent change in nominal compensation has been only 2.3 percent. during the entire Great Moderation (1986-2007), there was only one year where nominal compensation grew by less than 2.3 percent (it was 1.6 percent in 2002). The median during the Great Moderation was 5.2 percent. Using this as a measure of aggregate demand shows weakness. Of course, any product involving N would show weakness, so don’t get too excited, folks.
The Phillips-Curve half of the story does not go as smoothly. Perhaps the 2009-2010 pattern is a fluke, and you should just average those two numbers? In any event, we had higher wage growth throughout most of the Great Moderation, but not all of it. From 1993-1996, annual wage growth was 2.1 percent, 1.8 percent, 2.1 percent, and 3.1 percent, respectively. What caused that episode of sluggish wage growth? In that case, it was not weak aggregate demand.
Unless I’m missing something, using changes in total labor compensation as a proxy for changes in nominal demand seems to suggest that labor income is the only source of demand.
I prefer to think of purchases as being funded from current and expected wealth (including human capital), with current income from labor and capital augmenting wealth and debt having the opposite effect. Less than 5 percent of my income comes from labor, for example, yet I’m a big spender.