ABSTRACT
Policymakers have followed with great interest the search for a reliable early indicator of inflation. One measure that has received considerable attention is the changes in hourly compensation wages and benefits of workers. On average, compensation represents about two-thirds of the total cost of production, and economic theory suggests that an increase in the rate of compensation growth will lead to accelerating price inflation unless the increase is offset by greater productivity growth or a squeeze on profits. Theoretically, a link between compensation and prices could run in either direction. For instance, firms whose compensation costs are rising more rapidly than their productivity growth could at some point be expected to attempt to raise product prices. However, higher price inflation could itself trigger more rapid compensation growth through explicit or implicit contractual arrangements or through the influence of inflation expectations on the wage-setting process.
