Prices and Wages
As measured by the consumer price index (CPI), overall inflation fell from 3.4 percent during the 12 months of 2005 to 2.5 percent during 2006. The drop in overall CPI inflation was almost entirely due to the deceleration of energy prices from a 17.1-percent increase in 2005 to a 2.9- percent increase in 2006. Food prices increased 2.1 percent during 2006, similar to the pace of the previous year. Core CPI prices (that is, excluding food and energy) increased 2.6 percent during 2006, up from a 2.2-percent increase a year earlier.
After rising sharply during 2004 and 2005, prices of petroleum products slowed to a 6.1 percent increase during the 12 months of 2006, as the sharp rise through August was reversed later in the year. Prices of natural gas, which had risen sharply during 2005, fell 14 percent during 2006. As of mid- January 2007, prices in futures markets suggested that crude oil prices will rise modestly during 2007, while natural gas prices will increase substantially.
The 0.4 percentage point acceleration of core CPI prices was accounted for primarily by rent of shelter (which consists primarily of rent paid by renters and by the rent on owner-occupied dwellings), which accelerated to a 4.3 percent rate of increase during the 12 months of 2006 from 2.7 percent in 2005. Some of the acceleration in core CPI prices may also have been a delayed reaction to the rapid increase in energy prices from mid-2003 to mid- 2006, as the higher energy prices were absorbed into the prices of every service and commodity that requires inputs of energy or transportation. Econometric estimates (although imprecise) suggest that perhaps a quarter of a percentage point of the increases in the core CPI during the past year may be attributable to the past increases of these energy inputs. The Administration projects that the CPI will increase at a 2.6 percent annual rate during 2007 and 2008, about the same as the 2006 pace of the core CPI.
Hourly compensation (which is about 61 percent of nonfarm business output) has increased a bit faster in 2006 than in 2005. Nominal hourly compensation for workers in private industry increased 3.2 percent in 2006, up from 2.9 percent during the 12 months of 2005 according to the Employment Cost Index (ECI). All of this increase was from growth in wages and salaries (3.2 percent in 2006 versus 2.5 percent during 2005) while hourly benefits grew more slowly (3.1 percent versus 4.0 percent).
Another measure of hourly compensation published by the Department of Labor and derived from the National Income and Product Accounts has increased somewhat faster (at 4.3 percent) than the 3 percent increase in the ECI during the four quarters through the third quarter of 2006.
Unit labor costs have put little-if any-upward pressure on inflation thus far, and it appears unlikely that they will over the next year. Unit labor costs have increased at the same pace as the GDP price index, a 2.9 percent rate during the four quarters through the third quarter of 2006. The Administration expects the growth rate of hourly compensation to increase during 2007, as this nation's rapid productivity gains are shared by workers. But even with this acceleration in compensation, the expected strong pace of productivity growth will likely keep unit labor costs from putting upward pressure on inflation during 2007.
Moderate growth of hourly compensation and solid growth of productivity together with strong aggregate demand has driven the profit share of gross domestic income to its highest level since 1966.