Theory Meets Textual Analysis: Measuring Firm-Level Labor Cost Pressures and Inflation Pass-Through

We develop a novel measure of firm-level marginal labor cost and investigate its pass-through to inflation. To construct this measure, we apply textual analysis to earnings calls to identify discussions of labor-related topics such as higher costs, shortages, and hiring. Leveraging the theoretical principle that cost-minimizing firms equate marginal costs across variable inputs, we project changes in firms intermediate input revenue shares onto the intensity of labor-related discussions to quantify their contributions to marginal labor costs. This approach provides an economically-motivated way to reduce the multidimensional qualitative textual information into a single quantitative measure. An aggregate index from this measure tracks closely with conventional aggregate slack variables and outperforms them in forecasting inflation. When aggregated at the industry level, we find a significant but heterogeneous pass-through of marginal labor costs to PPI inflation, with the pass-through highest for service sector and near-zero for manufacturing. Consistent with the latter fact, firm-level data reveal that investment in automation mitigates the effects of higher labor cost pressures in manufacturing.