Inflation & Unit Labor Costs

Basic Effective Demand Limit, L = labor share index * 0.76

Effective demand on real GDP = rGDPeT/L (1 -(1 - 1/e)T/L)

Effective Demand Monetary rule with NGDP targeting = z(T² + L²) - (1 - z)(T + L) + (1+a)current core inflation + acore inflation average - 2acore inflation target

z = (2L + Natural real rate)/(2L² + 2L) ............................ T = capacity utilization*(1 - unemployment rate)
UT index = L - T ... (UT index goes to zero at limit of business cycle.)

New economic thinking... effective demand limit upon the utilization of labor and capital

« The AS-ED Model: Unit Labor Cost Adjustments | Main | Preliminary Takeaways from the AS-ED Model »

04/20/2013

Inflation & Unit Labor Costs

A follow-up to the previous post, where I presented the AS-ED model, Aggregate supply - Effective demand. In the model, there is a relationship between unit labor costs and inflation. As unit labor costs decrease, so does inflation. We can also see this relationship in the equation for effective labor share.

effective labor share = effective unit labor costs / price level

Since labor share of income is fairly constant over the years, we would expect to see unit labor costs and inflation move together. Here is a chart from FRED to show this...

This is exactly what we see. This relationship gets translated through the AS-ED model, along with other factors.

Posted by Edward Lambert on 04/20/2013 in AS-ED model | Permalink

Comments

You can follow this conversation by subscribing to the comment feed for this post.

This might be a dumb question but i was asked this in exam : can a increase in effective demand cause inflation .

Posted by: aditya | 05/26/2013 at 08:30 PM

The comments to this entry are closed.

Pages

Synopsis of Effective Demand

Data as of 3rdQ-2018
Effective Demand = $18.433 trillion
Real GDP = $18.671 trillion
Productive Capacity = $24.872 trillion
UT index is at effective demand limit = -0.92%
Effective demand limit = 74.1%
TFUR = 75.1%
ED Fed rate rule = 4.0%
Estimated Natural Real Interest rate = 2.3%
Short-term real interest rate = 2.8%

There is no recession for 3rdQ-2018. Chance of recession is growing as economy has now reached 2nd effective demand limit in this business cycle. I am forecasting that economic conditions will begin to contract in the second half of 2018.

Click on Graphs below to see updated data at FRED.

UT Index (measure of slack):