Introduction
This note summarizes my thoughts on the role of domestic wages in the CPI services aggregate and components. The essential point is that most components of the aggregate have a more limited direct connection to domestic wages than many talking heads suggest. Shelter is one obvious issue but many elements such as restaurant meals are not completely dominated by wages. Many other service elements are dominantly administrative or contractual in nature. This suggests that overtight monetary policy intended to inhibit wage inflation may damage job prospects and families but may not be likely to improve the inflation path at the margin.
CPI Services - Major Components
The bulk of the action is in the shelter components with the BoC policy directly responsible for Mortgage Interest Costs and indirectly for Rent through the impact on affordability.
The next graphic shows the major components with their weight in the aggregate CPI.
Home owner’s replacement cost reflects the cost of building a new home. For homeowners, this could be considered a component of the value of their implicit rental income. As such, it may not directly impact their planning or spending because it has no current cash implications.
Utility charges such as water and property taxes are administrative in nature and may rise with interest costs imposed on the municipalities. Passenger vehicle insurance premiums as well as home insurance are not likely to be influenced in a productive way by tightened monetary policy either. Higher interest rates likely imply higher costs.
Telephone services, internet access services and tuition fees are likely less tied to general labour costs than might be assumed. They are administrative in nature. Communication and internet services are usually adjusted on an infrequent contract basis, often annual.
Because of their international nature, it is unlikely that subscription services such as internet or video and audio plans will modify their pricing policies in response to general monetary initiatives unless there is a very large income/demand impact.
It should not be forgotten that CPI weights represent the share of expenditure across all households. That is why the CPI is referred to as a “plutocratic” index because most households would not make purchases in all categories. The simplest example is that most households either own or rent a primary dwelling but not both.
Labour Costs of Services
The next chart shows the labour cost share of key labour-intensive service industries. The symmetric IO tables were used to calculate a labour share on the basis of wages, supplementary labour costs and mixed income as a share of output. The main message is that the non-labour operating costs of businesses is larger than the labour costs. Keeping the lights and paying the rent and taxes are only some of the costs.
The next graphic shows the same data in tabular form. The higher rate in 2020 is partially the result of the Canada Emergency Wage Subsidy which reduced the total costs for the business. Wages thus became a bigger portion of output.
The sector identifiers are those used in the detailed input-output system. The important factor is that direct labour costs were less than half of the total expenses of any of these sectors.
Food Purchased Outside the Home
Various talking heads have discussed the implications of labour costs particularly in food services and implied that labour was the dominant cost. The CPI measure for food consumed in restaurants is a full-service measure encompassing the total cost including operating costs (rent, electricity), ingredients etc. The Detailed tables that I used did not separate table service from fast-food restaurants.
If 2019 could be considered a normal year, the share was 37.6%. This rose to 41.4% in 2020, partly due to a wage subsidy, and declined to 39.2%. My expectation would be that the share would decline further if the hospitality sector really normalizes.
Beer and liquor served in licensed premises are treated as services and are in categories that are separate from food services.
Other Service Categories
The final graphic below includes all of the service categories with weights. Most have very small weights in the aggregate CPI. The important factor to keep in mind is that private medical services (dental, vision etc.) are likely subject to professional regulation and not likely to respond to monetary policy.
Public transportation costs are heavily regulated and not likely constrained by higher interest rates. In fact, higher carrying costs for transportation utility debt will likely be passed on in prices.
Highly volatile prices such as travel tours and air transportation are possibly influenced by demand but energy costs, foreign supply, competition and other factors may outweigh the impact of monetary policy.
Summary
This note makes the case that wage costs are not the big drivers of non-shelter services inflation. Shelter costs have not been explicitly addressed because of the dominance of supply factors.