No Wage-Price Spiral if Wages Refuse to Spiral
This paper assumes that a central bank commits itself to maintaining an inflation target and then asks what measure of the inflation rate the central bank should use if it wants to maximize economic stability. The paper first formalizes this problem and examines its microeconomic foundations. It then shows how the weight of a sector in the stability price index depends on the sector’s characteristics, including size, cyclical sensitivity, sluggishness of price adjustment, and magnitude of sectoral shocks. When a numerical illustration of the problem is calibrated to U.S. data, one tentative conclusion is that a central bank that wants to achieve maximum stability of economic activity should use a price index that gives substantial weight to the level of nominal wages.The graph above shows that nominal wage increases have been falling since 2007, and are currently running about 2% annually, suggesting that there are no significant inflationary pressures right now for nominal wages. As Paul Krugman pointed on a recent post, "You can’t have a wage-price spiral if wages refuse to spiral; and all indications are that wages are being held down by high unemployment."