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Press Release

Cleveland Fed researchers examine falloff in inflation; labor’s declining share of output

Low inflation over the past several years a response to other developments in the economy, says Cleveland Fed researcher

Much of the weakness in PCE inflation over the past several years has been attributed to a sharp decline in energy prices and strengthening of the dollar. But inflation excluding volatile food and energy components (core PCE) has also been running significantly below the Federal Reserve’s long-run goal of 2 percent for PCE inflation. Federal Reserve Bank of Cleveland researcher Saeed Zaman says a simple forecasting model was able to explain most of the falloff in core PCE inflation as a response to other developments in the economy.

According to the model (called a Bayesian vector autoregression or BVAR), from late 2012 to mid-2013, the factors contributing to low inflation were a weaker-than-expected recovery in labor markets and weaker-than-expected energy prices. Thereafter, the labor market recovered more rapidly than expected, which put upward pressure on core inflation. However, over the past year, the sharp decline in energy prices and the stronger dollar have exerted significant downward pressure on core inflation, equal to about a 0.9 percentage point drag on average, which has more than offset the upward pressure coming from improving labor markets.

“Historical experience suggests that the impact of temporary energy and dollar shocks on core inflation is usually short-lived,” says Zaman. “Therefore, to the extent we are confident that economic activity will continue to increase moderately and slack in labor markets will continue to diminish, these factors should put upward pressure on inflation during the next few years.”  The model projects that core PCE inflation very gradually rises toward the Federal Reserve’s long-term inflation goal of 2 percent, ending 2017 at 1.8 percent. However, Zaman cautions that, as with any inflation forecast, there is considerable uncertainty around the forecast.

Read Explaining Low Inflation: Model-Based Decomposition

The same factors that have slowed capital accumulation may have weakened the demand for labor and decreased labor’s share of output, says Cleveland Fed researcher

Labor’s share of output -- the ratio of labor compensation to output – has trended downward for decades, but it has declined at a faster rate since the early 2000s. The labor share in the nonfarm business sector hovered around 64 percent in the 1950s, declined to 61.4 percent in 2002, and now stands close to 57 percent. According to Federal Reserve Bank of Cleveland researcher Filippo Occhino, since capital and labor tend to be complementary in the production of goods and services, the same factors that have slowed down capital accumulation since the early 2000s may have also weakened businesses’ demand for labor, leading to a faster decline in the labor share and a wider gap between wage growth and productivity growth.

One such factor, says Occhino, could be the deceleration of multifactor productivity. Since 2005, multifactor productivity has grown 0.58 percent annually on average, more than a percentage point slower than in the period from 1996-2004, which was characterized by fast productivity growth. (Multifactor productivity is a measure of the productivity of a combination of production inputs, or factors, such as labor, materials, and capital.)

Read Slow Capital Accumulation and the Decline in Labor’s Share of Output

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Federal Reserve Bank of Cleveland

The Federal Reserve Bank of Cleveland is one of 12 regional Reserve Banks that along with the Board of Governors in Washington DC comprise the Federal Reserve System. Part of the US central bank, the Cleveland Fed participates in the formulation of our nation’s monetary policy, supervises banking organizations, provides payment and other services to financial institutions and to the US Treasury, and performs many activities that support Federal Reserve operations System-wide. In addition, the Bank supports the well-being of communities across the Fourth Federal Reserve District through a wide array of research, outreach, and educational activities.

The Cleveland Fed, with branches in Cincinnati and Pittsburgh, serves an area that comprises Ohio, western Pennsylvania, eastern Kentucky, and the northern panhandle of West Virginia.

Media contact

Doug Campbell,, 513.218.1892