FED DOESN´T DEMAND WAGE GROWTH BEFORE INCREASING INTEREST RATE / THE WALL STREET JOURNAL

FED DOESN’T DEMAND WAGE GROWTH BEFORE INCREASING INTEREST RATE

By Jon Hilsenrath

Manuel Balce Ceneta/Associated Press

 

Federal Reserve officials have fuzzy views on how wage growth fits in with their objectives for the economy. They would like to see wages growing faster. It would give them confidence that the economy is closer to their dual goals of producing healthy job growth and modestly rising inflation. But the linkages between wages, jobs and inflation are unclear, and so they’re not banking on faster wage growth materializing.

In classical models of the economy, as the unemployment rate falls, slack in the job market diminishes, producing upward pressure on wages. Because wages are such a large component of business costs, wage pressures in turn get passed on to consumers in the form of higher consumer prices. But a growing body of research suggests the economy hasn’t been working like this for decades. Other factors — including global pressures, in addition to household and business views about the stability of inflation — have large effects that potentially outweigh any impact from domestic wages on prices.

A recent paper by Fed board economists Ekaterina Peneva and Jeremy Rudd finds little evidence that the ups and downs of wages had large effects on broader consumer price trends either before or after the 2007-2009 recession. “Wage developments are unlikely to be an important independent driver of (or an especially good guide to) future price developments,” they conclude.

Fed chairwoman Janet Yellen is well aware of all this research. In a speech in March, she laid out the connections she sees between wages, jobs and inflation and how they fit into her plans for short-term interest rates: “The outlook for wages is highly uncertain even if price inflation does move back to 2 percent and labor market conditions continue to improve as projected. For example, we cannot be sure about the future pace of productivity growth; nor can we be sure about other factors, such as global competition, the nature of technological change, and trends in unionization, that may also influence the pace of real wage growth over time. These factors, which are outside of the Federal Reserve’s control, likely explain why real wages have failed to keep pace with productivity growth for at least the past 15 years. For such reasons, we can never be sure what growth rate of nominal wages is consistent with stable consumer price inflation, and this uncertainty limits the usefulness of wage trends as an indicator of the Fed’s progress in achieving its inflation objective.”

This all matters now because the current pattern of wage growth is confounding.

Ms. Yellen said last month in semiannual testimony to Congress on the economy that wages showed tentative signs of picking up. Fed officials want to see this because it would imply the job market is getting back toward full health and producing pay gains for workers. The Labor Department’s employment cost index had risen 2.6% in the first quarter from a year earlier, it biggest increase since 2008.

Then on Friday, the Labor Department reported that the index tumbled down to a 2.0% growth rate in the second quarter, in line with its disappointing pace for most of the post-recession period. An upturn in wage growth seemed to disappear with one single disappointing report. Other measures of wage growth, including Labor Department measures of the average hourly earnings of workers, also are creeping along at a little above 2% per year.

This plays in complicated ways into the Fed’s thinking on interest rates. Fed officials expect to raise short-term interest rates this year. Will they proceed in an environment in which wage growth is not materializing?

Ms. Yellen said explicitly in that March speech that she is prepared to start moving interest rates up even before she sees sure signs that wages are rising faster. “That said,” she added, “I would be uncomfortable raising the federal funds rate if readings on wage growth, core consumer prices, and other indicators of underlying inflation pressures were to weaken.”

Given her stance, Friday’s employment cost report doesn’t look like a deal breaker for the Fed in its long-running debate about when to raise short-term interest rates. Wages appear to be stagnant but not clearly weakening, which is what she set out as her threshold for not acting. Still, it creates new doubts for officials and doesn’t help them build the confidence they’re hoping to build that the job market is nearing full employment and inflation rising toward 2%.

The September policy meeting is thus shaping up to be a cliffhanger for the Fed and markets. Officials could decide they want to take a bit more time to makes sense of all of this. Still, other evidence could emerge before then that convinces them to look past the report and act on rates. This coming Friday’s jobs report, and its measures of average hourly earnings of workers, now becomes all the more important for the Fed in its continued search for evidence that the economy is truly on the mend.