A Principal Components Approach to Estimating Labor Market Pressure and its Implications for Inflation

23 Pages Posted: 17 Jan 2008

See all articles by Michelle L. Barnes

Michelle L. Barnes

Federal Reserve Bank of Boston

Ryan Chahrour

Boston College - Department of Economics

Giovanni Olivei

Federal Reserve Bank of Boston

Jenny Tang

Federal Reserve Bank of Boston

Date Written: December 21, 2007

Abstract

We build a summary measure of labor market pressure that captures the common movement among a variety of labor market series. Obtained as the labor market series' first principal component, this measure explains a large portion of the variability of the underlying series. For this reason, it is a good summary indicator of labor market pressure. We show that the unemployment rate gap has tracked this summary measure closely over the past 35 years. At times, however, the summary measure and the unemployment rate gap have sent somewhat different signals. In terms of relying on the principal components summary measure vis-à-vis the unemployment rate gap for explaining inflation, we argue that the recent evolution of wage inflation is more consistent with the evolution of the summary measure than with the unemployment rate gap. This is because over the past two years the principal components summary measure has been suggesting less labor market pressure than the unemployment rate gap. Over the past 35 years, however, there is little systematic evidence favoring the summary measure of labor market pressure over the unemployment rate gap as a predictor of inflation.

Suggested Citation

Barnes, Michelle L. and Chahrour, Ryan A. and Olivei, Giovanni and Tang, Gaoyan, A Principal Components Approach to Estimating Labor Market Pressure and its Implications for Inflation (December 21, 2007). FRB of Boston Public Policy Brief No. 07-2. Available at SSRN: https://ssrn.com/abstract=1084914 or http://dx.doi.org/10.2139/ssrn.1084914

Michelle L. Barnes (Contact Author)

Federal Reserve Bank of Boston ( email )

600 Atlantic Avenue
Boston, MA 02210
United States

Ryan A. Chahrour

Boston College - Department of Economics ( email )

140 Commonwealth Avenue
Chestnut Hill, MA 02467
United States

HOME PAGE: http://www.chahrour.net

Giovanni Olivei

Federal Reserve Bank of Boston ( email )

600 Atlantic Avenue
Boston, MA 02210
United States

Gaoyan Tang

Federal Reserve Bank of Boston ( email )

600 Atlantic Avenue
Boston, MA 02210
United States

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