1

1Sidney Weintraub. “A Tax-Based Incomes Policy,” Journal of economic Issues, June 1971.

Initial points:

Inflation is partly the consequence of the never ending struggle over the distribution of income between various groups--e.g., unionized workers, professionals, retirees, public sector employees, and so forth.

As these groups seek to raise their incomes, money income can get ahead of productivity growth--putting upward pressure on unit labor costs.

The key to understanding inflation is in understanding the relationship between average money income and average labor productivity.

Definitions

P : Price levelQ : Real outputY1 : Gross business product (Gross money

income)N : Number of persons employedy 2: Average money income(y = Y/N)A : Average product of labor (A = Q/N)w : Average (money) wagek: Average markup over unit labor cost

1Omits nonprofit activities of households, government agencies, and nonprofit institutions.

2Includes wages, profits, salaries, rents, interest, business taxes, and depreciation.

The Model

YPQ (1)

Therefore,

Q

YP (2)

Divide Y and Q by N to obtain:

NQ

NYP

/

/ (3)

Now rewrite (3) to obtain:

A

yP (4)

Equation (4) tells usthat the price level is

determined by the ratioof average moneyincome to average

productivity

AAyyQQYYPP ///// (5)

Equation (5) indicates that the price level must rise if the rate of increase of ave. money income exceeds the rate of increase of labor productivity. We now focus on the relationship between money wages and labor productivity.

kwNPQY (6)

That is, gross money income is equal to the mark-up over unit labor cost (ULC) times the average money wage times the number of persons employed. Unit labor cost is defined as:

AwUCL /

The Wage Cost mark-up equation is written as follows:

P = kw/A (8)

(7)

Employment Cost Index, Private Industry

June, 1989 = 100

U.S., 1985-97

Source: Economic Report of the President, Table B-48

Year

97969594939291908988878685

150145140135130125120115110105100959085807570

Wages and

Salaries

Benefits

Percent Change in Private Employment Cost, 1986-97

U.S. , from the previous year

Source: Economic Report of the President, Table B-48

Year

979695949392919089888786

Perc

en

t

7

6

5

4

3

2

1

Wages and

Salaries

Benefits

Private Employment Cost Index, 1986-97

June, 1989 = 100

Source: Economic Report of the President, Table B-48

Year

97969594939291908988878685

140

135

130

125

120

115

110

105

100

95

90

8580

135

131127

124120

116112

107

102

98

9390

87

Annual Percent Change In Productivity, Compensation, and Unit Labor Cost

U.S., 1971-83

Source: Economic Report of the President, Table B-49

Year

83828180797877767574737271

12

10

8

6

4

2

0

-2

-4

Output per hour

Compensation

per hour

Unit labor cost

Productivity, Compensation, and Unit Labor Cost, 1988-97

1992 = 100

Source: Economic Report of the President, 1998

YEAR

1997199619951994199319921991199019891988

120

110

100

90

80

Productivity

Hourly compensation

Unit Labor Cost

Productivity, Compensation, and Unit Labor Cost in the U.S., 1989-97

This is a type of cost-push inflation

Profit-Push Inflation: If ULC remains constant, equation (8) indicates that the price level can only rise if k increases. Most studies indicate that k is remarkably stable over time (though the time path of k differs across industries).

Wage and Salary-Push Inflation:Wage and Salary-Push inflation arises from an increase in ULC over time.

2 sub-types

. Incomes policies are

designed to tie increases in

nominal wage and salary compensation to

increases in labor productivity through

the use of tax incentives