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Stephen,

How about trying this to solve the puzzel.

Go to the St.Louise Fed website here:

http://research.stlouisfed.org/fred2/release?rid=47&soid=22

Then under Productivity and Costs try these data sets: For productivity use -> Business Sector: Output Per Hour of All Persons; for compensation use -> Business Sector: Compensation Per Hour; and for the price deflator use -> Business Sector: Implicit Price Deflator.

Deflate the Compensation Per Hour by the Implicit Price Deflator to get Real Compensation Per Hour. (Do not use the Real Compensation Per Hour series on the website since, as we talked about earlier, it is deflated by a consumption deflator - the CPI). You can then compare the two series (productivity and real compensation) from 1947 to 2006. As you will see, the puzzel disappears, and as economic theory says, compensation is linked to productivity.

Stephen,

In my haste I made a mistake. Please use the NONFARM Business Sector for the above data sets.

Ah. That does shrink the gap to an accumulated shortfall of only 4%, so that accounts for about half of the gap in the original graph that used CPI.

(Oops - missed your correction. It's getting late, so I'll look at it again tomorrow. Again, thanks very much.)

It's not clear it's a mistake to deflate by the CPI-U. If one wants to measure the real compensation from the perspective of the worker rather than the firm, then one would want to do exactly what BLS does. If one wants to see whether firms are equating the marginal product of labor to the real product wage (i.e., the wage deflated by the price of the firm's output) then one should do what Lazear did in his presentation.


I've now appended a graph of the wage deflated by the nonfarm business sector deflator (CEA preferred), by the CPI-U (BLS reported), and by CPI-RS (the research version of the CPI), preferred by some commentators, all against output per hour in the nonfarm business sector. See here

When comparing productivity and compensation, I think the choice of the deflator boils down to how one believes workers are compensated. If you believe as I do that workers are compensated by employers on the basis of what they are producing, then one should use the output price deflator. On the other hand, if you believe workers are compensated on the the basis of what they consume, then use the consumption deflator.

Menzie makes a great point when he writes, "If one wants to see whether firms are equating the marginal product of labor to the real product wage (i.e., the wage deflated by the price of the firm's output) then one should do what Lazear did in his presentation."

When testing economic theory use the output deflator.

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