Business Activity Growth Slows While Labor Cost Inflation Hits Record High: Chicago Fed

A "Help Wanted" sign is posted beside coronavirus safety guidelines in front of a restaurant in Los Angeles on May 28, 2021. Frederic J. Brown/AFP via Getty Images

A new report from the Chicago Federal Reserve on business conditions in the central bank’s 7th district paints a picture of slowing growth and historically high price pressures, with labor cost inflation at a record high.

The Chicago Fed Survey of Business Conditions, released on Sept. 13, shows that the headline business activity index fell to a reading of minus 2 in August from plus 14 in July, suggesting August growth fell below trend.

At the same time, labor costs rose to a series high of plus 42 in August, up by two points from July and the highest reading in the eight-year history of the series. Nonlabor cost pressures—led by materials, shipping, and energy—held steady over the month at plus 23, a level not seen since mid-2018.

The report is based on a survey of more than 800 business contacts in the 7th Federal Reserve District and provides input into the Fed’s recently released “Beige Book,” which provides an economic snapshot of the United States from early July through August, based on reporting from the central bank’s 12 districts.

While the Chicago Fed survey is limited in scope to the 7th district, it provides insight into the state of the broader economy. According to Thomas Walstrum, a senior business economist at the Chicago Fed, the survey’s headline business activity index has tracked real gross domestic product (GDP) growth from 2013 to the present “quite well.”

“The index is less volatile than real GDP growth, so while it usually is right about whether growth sped up or slowed down from quarter to quarter, it often understates the degree of the pickups and slowdowns,” Walstrum wrote in an explainer note.

Despite the slowdown in the current business activity measure, respondents’ outlooks for the economy over the next 12 months remained optimistic, with 60 percent saying that they expect an increase in economic activity in the coming year, according to the Chicago Fed report. Still, the 12-month forward outlook deteriorated significantly in August compared to July, dropping over the month to a reading of plus 14 from plus 44.

The pace of hiring fell, as did respondents’ expectations for the pace of hiring over the next 12 months, though both indexes remained in positive territory.

The Fed’s Beige Book, which was partly informed by the Chicago Fed’s data, shows that U.S. businesses were facing supply-crunch-driven inflation in input costs, with many saying that they expect to pass those higher prices to consumers.

Resource shortages were “pervasive” and input price pressures were “widespread,” with many businesses reporting difficulty sourcing key inputs, even at greatly increased prices, according to the Beige Book report.

“Firms have continued to report exceptionally widespread increases in input prices—particularly in the construction, manufacturing, wholesale trade, and transportation and warehousing industries,” the report authors wrote, noting that contacts in all sectors expect widespread input price increases for the rest of the year.

Half of the districts described input price inflation as “strong,” while the other half characterized it as “moderate.” In many cases, higher input costs are likely to translate into higher prices for consumers.

“A sizable share of contacts in all sectors plan to increase prices over the next six months,” the authors wrote, noting that several of the 12 districts indicated that businesses expect “significant hikes” in their selling prices in the months ahead.

Adding fuel to the inflationary dynamic were upward price pressures on wages, with most businesses characterizing wage growth as “strong” as demand for workers continued to climb.

“All districts noted extensive labor shortages that were constraining employment and, in many cases, impending business activity,” the authors of the report wrote.

Increased worker turnover, a rise in early retirements, child care needs, and enhanced unemployment benefits were all noted as factors driving the hiring crunch, according to the report, with businesses resorting to more frequent raises, bonuses, training, and flexible work arrangements to attract and keep staff.

Echoing the findings in the Chicago Fed’s business activity index, the Beige Book shows that overall economic activity “downshifted slightly to a moderate pace” in the reporting period, with the softening mostly down to a pullback in dining out, travel, and tourism, mostly reflecting concern around the spread of the Delta variant of the CCP (Chinese Communist Party) virus.