Unless markups shrink to absorb the attendant acceleration in unit labor costs, the result would be upward pressure on inflation.

We do know that as the rate of growth has slowed down, unit labor costs have gone up as they invariably do in such a period. But we've seen no evidence that those costs are being passed through into final prices in any material way. Similarly, we see a fairly extraordinary increase in energy costs. And here again, separating corporations into non-energy, non-financial, we've tried to trace the movement of energy costs into prices, and we've found that almost all does not going to final goods prices, but is squeezing profit margins, which is the same thing as unit labor costs.

From Q&A session, as reported by Bloomberg News

I am struck by the tenacity of the belief by some that a 4% unemployment rate must bring inflation, and I am surprised when I read the speeches of some on the Fed that a form of Marxism has taken root there.  It is Chico Marxism:  who are you going to believe, me or your own eyes?  And they persist in believing themselves and not our own eyes, which say taht a 4% unemployment rate has been quite consistent with low inflation.

How is it possible, first, for hourly compensation growth to be flat or falling in an ever-tightening labor market? Let me begin by suggesting what does not explain it. You may recall that two or three years ago I was arguing that fear of job obsolescence was a major factor suppressing the nominal increase in compensation per hour. That factor clearly has not gotten worse; if anything, it has eased. The International Survey Research Company is the source of the data that I was quoting back in 1995 and 1996, as you may remember. When workers were asked whether they frequently were concerned about being laid off, 46 percent responded “yes” in 1995 and 1996 compared with figures in the teens or in the twenties throughout the 1980s. The 46 percent number is now down to 37 percent. Statistics on job leavers, another indicator I would use, likewise do not indicate any significant change. So an increase in uncertainty and the fear of job loss amongst workers cannot account for this extraordinary combination of low unemployment and no acceleration in hourly compensation.

As I pointed out here last February, polls indicated that despite the significant fall in the unemployment rate, the proportion of workers in larger establishments fearful of being laid off rose from 25 percent in 1991 to 46 percent by 1996. It should not have been surprising then that strike activity in the 1990s has been lower than it has been in decades and that new labor union contracts have been longer and have given greater emphasis to job security. Nor should it have been unexpected that the number of workers voluntarily leaving their jobs to seek other employment has not risen in this period of tight labor markets.

To be sure, since last year, surveys have indicated that the proportion of workers fearful of layoff has stabilized and the number of voluntary job leavers has edged up. And, indeed, perhaps as a consequence, wage gains have accelerated some. But increases in the Employment Cost Index still trail behind what previous relationships to tight labor markets would have suggested, and a lingering sense of fear or uncertainty seems still to pervade the job market, though to a somewhat lesser extent.

But the rate of pay increase still was markedly less than historical relationships with labor market conditions would have predicted. Atypical restraint on compensation increases has been evident for a few years now and appears to be mainly the consequence of greater worker insecurity. In 1991, at the bottom of the recession, a survey of workers at large firms by International Survey Research Corporation indicated that 25 percent feared being laid off. In 1996, despite the sharply lower unemployment rate and the tighter labor market, the same survey organization found that 46 percent were fearful of a job layoff.