As a further follow up on the NAIRU discussions mentioned in my last two posts, I have looked at the historical relationship between wage inflation and unemployment in the UK.
The first of the two graphs below shows annual change in average earnings against unemployment from 1973 to 2016. The second graph shows the change in the change, what we might think of as the acceleration of wage inflation. I have divided the points into three periods:
1973 - 1979: the period before the Thatcher government
1980 - 1991: up to inflation targeting
1992 - 2016: the period of inflation targeting
The trend line covers the whole period.
A few points are worth making here.
Both charts show quite a wide scatter. Although both show a vague trend across the whole period, the correlation is not particularly strong in either.
Although the correlation is somewhat weak, the charts suggest that both the level of wage inflation and its acceleration are negatively correlated with unemployment.
There appears to be a somewhat better correlation if we look at the periods individually. Each individual period generally continues to show the same direction of correlation. However, the steepness declines over time, both in relation to wage inflation and its acceleration.
For the period of inflation targeting, there appears to be very little correlation between unemployment and the actual level of wage inflation, whilst there is still a slight correlation with its acceleration. This is probably the opposite of what I would have expected.
I addition to displaying the steepest relationship, the plot for the 70's also shows the greatest scatter. This probably reflects various external factors such as the oil price shock and the social contract.
The only really clear conclusion here is that the relationship between these variables is a complex one, but it does appear that there is some connection between unemployment and not only, wage inflation, but also its acceleration.