Today, the NY Times is running an article on the oncoming recovery, citing the typical mechanisms that jumpstart the economy: inventory replacement, population growth, or price declines (or slowing price increases). In spite of an economic recovery, key markets still have a "long way to go"; this is especially true with prices.
This labor cycle has been just awful, as the top chart shows. The private payroll slashed >600,000 jobs every month since October 2008. And the job declines are expected to continue.
The massive labor declines helped to push the employment cost index (ECI) growth down to 1.96% over the year, a record since the series was first measured in 2001. The chart below illustrates the relationship between the private ECI (total compensation measure, Table 1 here) and the private payroll (both measured in annual growth rates).
The sample size is small, as the ECI data are available on a quarterly basis since just 2001 (29 data points for the annual growth series); however, the relationship does show an R^2 of 0.33. Accordingly, as the labor market sheds more jobs, the ECI growth is expected to slow further.
Let's say that the payroll slashes another 1 million private jobs over the two months, then the relationship above suggests that the ECI growth will slow to just 1.3% over the year. However, as the lone Q1 2009 value shows, history is likely not the best predictor, since neither the ECI nor the payroll have seen these levels of losses over the sample period.
My point is that the slowing wage growth probably has some downward momentum left in the pipeline.
The chart illustrates the 6-month growth in prices (headline and core, which extracts the effects of energy an food prices) on an annualized basis. Over the last six months, energy prices have tumbled, dragging down headline inflation (deflation) to around -5% annualized in March. Illustrating inflation in this manner is convenient to quantify the price momentum over the recent past, rather than over the last year.
Based on the expectation that wages are expected to fall further, core prices, which are very much lagged to the economy and still growing at over a 1% annualized rate in the last six months, are set to fall. There's likely nothing that Bernanke can do about that.
Slowing wage growth is the mechanism by which the market clears its produced goods and services while aggregate demand is falling; however, eventually, it could become a problem.