A closer look at the employment cost index

Labor costs have recently come under scrutiny by policymakers, business economists, and financial market participants. The primary concern has been that tight labor markets might lead to faster compensation growth and, ultimately, to upward pressure on general inflation. The employment cost index (ECI) has received particularly close attention because many analysts consider it to be one of the best measures of labor cost inflation. Other analysts, however, have questioned whether the ECI and other labor cost measures are useful in inflation forecasting. One reason for doubting the ECI's inflation forecasting value is that a moderate upward trend in ECI growth over the last three years has, so far, not been matched by a rise in the general inflation rate.> But economic analysts may have other reasons than inflation forecasting for using the ECI. Detailed information on employment cost trends may help analyze labor market developments and, indirectly, may reflect broader economic trends outside the labor market. In addition, companies may find the ECI useful in wage setting and other compensation decisions. Given the high profile that the index has sometimes assumed in the business press and financial markets, it is time to take a closer look at the ECI and evaluate its possible uses.> Garner examines the ECI and other labor cost measures. He finds that the ECI is quite useful in analyzing broad economic trends, such as the shift in jobs toward the service sector, and in making business decisions about employee compensation. He concludes, however, that the ECI is more useful for labor market analysis and wage setting than for general inflation forecasting.