Let’s start with that old scourge, wage inflation. Forget for a minute that there is no such beast as wage inflation. Wages are a price: the price of labor. Inflation is a generalized rise in the price level. (The fact that the price level has been redefined from a fixed basket to a grab bag of options is a matter for another day.)

Higher wages are higher wages. They can be a symptom of inflation, rising along with the prices of goods and services. But in terms of a driver of inflation, prices lead wages, not the other way around.

That observation, supported by empirical results, led business cycle gurus to include a wage measure — specifically unit labor costs for manufacturing — in the Index of Lagging Indicators, compiled each month by the Conference Board. The global business and research organization, which publishes surveys of consumer and business confidence, assumed responsibility for the indexes of leading, coincident and lagging indicators in 1995 when budget constraints forced the Bureau of Economic Analysis to off-load the series.

Friday the Bureau of Labor Statistics reported that average hourly earnings, the narrowest measure of wages, rose 4.2 percent in December, matching the five-year high from the previous month. The rise in wages, along with a larger-than- expected increase of 167,000 in non-farm payrolls, sent stocks and bonds tumbling and prompted interest-rate futures markets to rethink the likelihood of a near-term rate cut from the Federal Reserve.

And no wonder. The Fed has been out in front when it comes to voicing concerns about wage and other cost-push inflation.

“The possibility that the tightness of the labor market could lead to sustained upward pressure on nominal labor costs was viewed as an upside risk to the expected moderation in inflation,” the Fed said in the minutes from the Dec. 12 meeting, released last week.

The whole cost-push model never made sense to the late Nobel Laureate Milton Friedman 30 to 40 years ago, when regulation made the economy much less flexible. It makes even less sense today, when labor is fungible.

According to Friedman, costs don’t arbitrarily levitate on their own, even though that’s how it appears to individual businessmen. Demand pushes prices — and costs — up when the central bank creates too much money relative to the goods and services the economy can provide.

So why does the myth persist that higher costs push prices higher?

“Because it’s a pacifier, it’s easy to talk about,” says Jim Glassman, senior U.S. economist at JPMorgan Chase & Co. “The two generally move together.”

Average hourly earnings, which is part of the BLS’s current employment survey, is the narrowest gauge of labor costs — it covers production and non-supervisory workers, or 80 percent of the workforce — which is why it’s being discontinued in 2010.

Early this year, the BLS will begin publishing a new series that measures the total earnings of all workers on an experimental basis.

Even with the broader series, wages are only “part of compensation,” Glassman says. “The rate of increase in benefits has slowed.”

Benefits as measured by the Employment Cost Index rose 3.3 percent in the third quarter of 2006 from a year earlier, less than half the 7 percent peak rate in the second quarter of 2004.

The warped thinking about cost-push inflation doesn’t apply only to labor, the largest input for businesses. Commodity prices get thrown into the confused mix as well.

With raw materials prices on a tear until recently, it was impossible to read a financial story without seeing a reference to fears that businesses might pass the costs through to their customers, setting off a wage-price spiral.

How very ‘70s! With crude oil prices almost hitting US$80 a barrel last year, it’s amazing we got away without a bout of stagflation.

I had another out-of-body experience last week, listening to economist Catherine Mann of Brandeis University tell Bloomberg TV’s Mike McKee that capacity utilization was tight, posing another source of inflation pressure.

Capacity utilization? Now there’s a relic from the Mesozoic Era!

Capacity utilization, or the percent of productive capacity being utilized, in manufacturing stood at 80.3 percent in November, about a half-point above its 1972-2005 average, according to the Fed. U.S. manufacturing employment has been falling since the late 1970s, partly in response to greater efficiency and partly due to the shift in production to countries where labor is dirt cheap. More than 5.4 million manufacturing jobs have been lost since 1979, a 28 percent decline.

“Manufacturing is global,” Glassman says. “Capacity has been growing rapidly overseas.”

The rise in wages and alleged constraints on capacity are coming at a time when inflation is rolling over. Even if it continues to decelerate, economists are unlikely to alter their views on cost-push inflation. And they’ll still sound as if they live on another planet.

“Actually they live on Pluto,” Glassman says. “And Pluto is no longer a planet.”

Caroline Baum, author of “Just What I Said,” is a columnist for Bloomberg News.