What was Mr Tharman talking about?

My layman brain is throbbing with a big, fat headache. Are there any economists out there that can explain?

Our Finance Minister says that wage increases will fuel a second round of inflation. I have been trying to work out the dynamics in my mind as rationally as I can. I have tried speaking to people to see if anyone can shed light on the relationship between wages and inflation. Looks like it can be argued both ways (for and against the Minister’s proposition). After doing a bit of google-searching, I have discovered this excellent policy discussion paper:

“Does Wage Inflation Cause Price Inflation?” by Gregory D. Hess and Mark E. Schweltzer (Policy Discussion Paper, Number 10, April 2000), Federal Reserve Bank of Cleveland

Gregory D. Hess is the Danforth-Lewis Professor of Economics at Oberlin College and an academic consultant to the Federal Reserve Bank of Cleveland.

Mark E. Schweitzer is an economist at the Federal Reserve Bank of Cleveland.

The Abstract of the discussion paper says it all:
“Recent attention has turned from unemployment levels to wage growth as an indicator of imminent inflation. But, is there any evidence to support the assumption that increased wages cause inflation? This study updates and expands earlier research into this question and finds little support for the view that higher wages cause higher prices. On the contrary, the authors find more evidence that higher prices lead to wage growth”

The conclusion that they reach at the end is:
“There is little systematic evidence that wages (either conventionally measured by compensation or adjusted through productivity and converted to unit labour costs) are helpful for predicting inflation. In fact, there is more evidence that inflation helps predict wages. The current emphasis on using changes in wage rates to forecast short-term inflation pressure would therefore appear to be unwarranted. The policy conclusion to be drawn is that inflation can appear regardless of recent wage trends.”

The policy paper can be accessed online:
http://65.89.19.70/research/POLICYDIS/pd1.PDF

On a related note, the European Central Bank recently warned against wage increases and alleged that wage increases would lead to another round of inflation. But, the European Trade Union Confederation has rebutted that. The following is an extract from a Reuters article dated 1 July 2008:


BRUSSELS, July 1 (Reuters) – Trade unions in the European Union chided the European Central Bank on Tuesday for urging caps on wage growth and reiterated their opposition to any interest rate increase.
The European Trade Union Confederation said ongoing wage bargaining or expected wage trends would trigger no second-round inflationary effects — the feed-through of high energy and food prices into the wider economy — as feared by the ECB.
“The ECB’s concerns on wages are unfounded and dangerous. The ETUC calls upon the ECB to stop using wages as an alibi to hike interest rates,” ETUC General Secretary John Monks said in a statement.

So, how did our trade unions respond? In fact, our Finance Minister was speaking directly to one of our trade unions. He was at a dinner organised by the Singapore Industrial and Services Employees’ Union. Mr Philip Lee, the Deputy President of the Union is reported to have said that his union would not push for higher wages. Incidentally, Mr Tharman is the Chairman of the Union’s Council of Advisors. Looks like the Union would be taking the Chairman’s suggestion to heart.

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