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Schwab Guide to Economic Indicators: Employment Cost Index (ECI) by the Schwab Center for Financial Research November 19, 2007 What is it? The employment cost index (ECI) is a wage-inflation indicator produced quarterly by the Bureau of Labor Statistics (BLS) measuring wages, salaries and benefits. It records changes in compensation costs for civilian workers, which include nonfarm private industry, and state and local government employees. The BLS provides data for the overall ECI and its components of wages, salaries and employer costs for employee benefits. These are presented as follows:
High. It's widely followed because of its impact on inflation. In general, all costs associated with labor represent roughly two-thirds of the price of finished goods and services; however, this impact can vary widely by industry. The ECI is one of several key indicators monitored by the Federal Reserve as it sets monetary policy. What impact does it have on the market? The degree to which the ECI meets expectations is typically one of the most influential aspects of the report.  Bond prices typically fall (yields rise) in reaction to higher-than-expected ECI readings because this measure of wage inflation has the potential to spillover into other traditional price indexes. This reaction can be more pronounced when the economy is growing near or above its potential because that's when it's more susceptible to allowing inflation pressures to become imbedded. Stock prices may also fall. Why? A rise in bond yields can eventually make bonds more attractive once the fall in bond prices settles down. Compared to where the weights of stocks and bonds were in your portfolio, the typical thing to do in response to this change in valuation would be to sell a portion of your stock portfolio and put the proceeds into bonds. Alternatively, if the ECI becomes subdued, this can give a boost to stock and bond prices. Low ECI readings help reduce inflation pressure while potentially increasing corporate profits, thereby supporting stocks. How is it calculated? Wage, salary and benefits data are collected from approximately 12,000 private firms and 800 state and local government agencies. The data are collected for the pay period including the 12th day of the survey months of March, June, September and December. According to the BLS, "Wages and salaries are defined as the hourly straight-time wage rate or, for workers not paid on an hourly basis, straight-time earnings divided by the corresponding hours. Production bonuses, incentive earnings, commission payments, and cost-of-living adjustments are included in straight-time wage and salary rates." "Benefits covered by the ECI are: paid leave—vacations, holidays, sick leave, and other leave; supplemental pay—premium pay for work in addition to the regular work schedule (such as overtime, weekends, and holidays), shift differentials, and nonproduction bonuses (such as referral bonuses and attendance bonuses); insurance benefits—life, health, short-term disability, and long-term disability; retirement and savings benefits—defined benefit and defined contribution plans; and legally required benefits—Social Security, Medicare, and federal and state unemployment insurance," per the BLS. It does not include stock options. "To be included in the ECI, employees in occupations must receive cash payments from the establishment for services performed and the establishment must pay the employer's portion of Medicare taxes on that individual's wages. Major exclusions from the survey are the self- employed, individuals who set their own pay (for example, proprietors, owners, major stockholders, and partners in unincorporated firms), volunteers, unpaid workers, family members being paid token wages, individuals receiving long-term disability compensation, and U.S. citizens working overseas," states the BLS. The quarterly data is presented on seasonally and not seasonally adjusted basis as:
Analysts use the ECI because it adjusts for changes in the composition of the workforce, such as a movement from manufacturing to service-oriented jobs. Many times these shifts in the occupational makeup of the United States are associated with higher pay. Sometimes these shifts result in lower pay. That's why the composition adjustment is important because it helps prevent these redistributions of the workforce from being unfairly characterized as wage inflation or wage deflation. Given the various data included in the ECI report, compensation trends can be better understood by industry, occupation, occupational group and union versus non-union. Wages and salaries can be viewed separately from benefits. Not only is this information used by the Fed in setting monetary policy, it's also used by corporations and unions to negotiate compensation agreements. In the eyes of the Fed, the ECI is used to better understand wage inflation and its potential impact on other broader gauges of inflation. For example, the ECI includes bonus compensation. Since annual bonuses are typically paid in either the fourth quarter or the first quarter, the Fed may not be overly alarmed if the ECI perks up a little bit during these quarters. An example of how the Fed could utilize the separation of wages and salaries from benefits in setting monetary policy can be illustrated by using a hypothetical case involving pensions. Contributions to pensions made by corporations are classified as benefits within the ECI. If contributions to pensions wane, the benefits portion of the ECI could soften. This could mask what is going on with the overall ECI. Fortunately, the report separates the ECI's components. If the wages and salaries component grows at too fast a rate, the Fed might be more apt to raise interest rates despite the softness in benefits. That is, the Fed probably won't be fooled by what could seemingly be a benign-looking overall ECI. Note: the ECI is a lagging indicator. Rises in the index today are usually the result of too much economic stimulus several months prior. That stimulus can come in the form of accommodative (low) interest rate policy by the Fed. At some point within this segment of the business cycle, the Fed begins to raise short-term interest rates in order to remove excess stimulus. Once the cumulative amount of rate hikes is finally considered restrictive, it can take roughly six months for economic growth to begin to slow. However, it can take approximately six more months for inflation readings, such as the ECI, to begin to subside. Conversely, decreases in the ECI are usually the result of too much economic restraint several months prior. At some point within this segment of the business cycle, the Fed begins to cut short-term interest rates in order to remove unneeded restraint. Once the cumulative amount of rate cuts is finally considered stimulative, it can take roughly six months for economic growth to begin to increase and another six months for the ECI to begin to rise. The lag times described in these examples are general in nature. They can vary from one business cycle to the next. When is it released? The BLS releases the ECI approximately one month after the close of the quarter. You can find it on the BLS home page for employment costs under the Economic News Releases section, labeled Employment Cost Index. The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The type of securities mentioned may not be suitable for everyone. Each investor needs to review a security transaction for his or her own particular situation. Data contained here is obtained from what are considered reliable sources; however, its accuracy, completeness or reliability cannot be guaranteed. (2007-5771) Return to Top |
Schwab Guide to Economic Indicators
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