Federal Reserve Chair Jerome Powell and his colleagues confront a “legitimate head scratcher” as they probe how high to raise interest rates in the coming months: Why is wage growth slowing if the jobs market is so tight?
(Bloomberg) — Federal Reserve Chair Jerome Powell and his colleagues confront a “legitimate head scratcher” as they probe how high to raise interest rates in the coming months: Why is wage growth slowing if the jobs market is so tight?
The answer will go a long way in determining whether the Fed can bring down inflation without doing that much damage to employment and the economy. If pressure on pay keeps easing even as employers keep hiring, policy makers may feel less compelled to push rates ever deeper into restrictive territory in their drive to return inflation to their 2% goal.
The paradox: the US unemployment rate has tumbled to the lowest in more than half a century — seemingly giving workers all the more power to demand higher pay. But a key measure of wages and benefits is decelerating. It results in what White House economist Jared Bernstein calls a real “head scratcher.”
With supply-chain snarls unraveling, Powell has zeroed in on the labor market as an important source of inflationary risk. He’s cited the significance of labor costs for service industries ranging from health care to restaurants in arguing that wages are rising too quickly to be consistent with the Fed’s 2% price goal.
Many economists say it will take serious damage to the job market to defuse such price pressures. But there’s another scenario starting to gain attention: call it a reverse wage-price spiral. And it may be the best bet for Powell’s coveted “soft landing,” where inflation comes down without a harmful recession.
Moody’s Analytics chief economist Mark Zandi posits the wage deceleration is due to a downshift in inflation expectations held by workers, as well as their bosses.
Reduced expectations for living costs — reflecting lower gasoline prices and the anticipated impact of aggressive Fed interest-rate increases — lead to tempered wage demands. That in turn means less pressure on companies to raise prices. For the Fed, the bottom line is it may not have to force such a big downturn in the job market.
‘Step Closer’
“A slowdown in wage growth without a significant increase in the unemployment rate puts us one step closer to a soft landing,” said Sinem Buber, lead economist at ZipRecruiter, an online job-matching site that worked with over 40 million applicants last year.
The reverse wage-price spiral isn’t universally endorsed. Former chief White House economist Jason Furman has put forth an alternative hypothesis: wage-price persistence.
Labor costs might have come off the boil as the burst of hiring spurred by the economy’s reopening abated. But the jobs market remains out of whack, as demand for labor still far outstrips supply. That will keep wage increases — and inflation — elevated, according to the Furman hypothesis.
And that would necessitate even higher rates from the Fed, ultimately involving a greater risk of an economic contraction.
Recession Scenario
“A recession will eventually be necessary” to get inflation back to the Fed’s comfort zone, said Bruce Kasman, chief economist at JPMorgan Chase & Co.
The Fed’s favorite measure of labor expenses, the employment cost index, has shown three straight quarters of smaller advances. A narrower measure — average hourly earnings of employees — has also slowed, with a year-on-year gain of 4.4% in January, down from 5.9% last March.
The easing in pay pressures has occurred even with unemployment at the lowest level since 1969 and almost double the number of job openings compared with job seekers.
Zandi argues that what drove the outsized pay increases seen a year ago was a surge in inflation coming out of the pandemic that was compounded by Russia’s invasion of Ukraine.
Workers responded to the rise in the prices of gasoline and other necessities by pushing for higher pay. Now that price gains have come down from the peak, the demand for bigger wage gains should ease, he said.
What Bloomberg Economics Says…
“While the dimensions of the puzzle are still far from clear, there’s a possibility of a wage-price spiral operating in a favorable direction.”
— David Wilcox, director of US economic research and a former Fed official
Zandi, who sees better-than-even odds the US will avoid a recession, doesn’t dispute the jobs market is tight. He just doesn’t think it’s as taut as some economists do. The share of the prime-age working population that’s employed is 80%, consistent with full employment but not beyond it, he said.
Count Former Treasury Secretary Lawrence Summers as skeptical. In a VoxEU column Tuesday with fellow economist Alex Domash, Summers attributed the recent slowdown in wage growth to a fading of temporary shocks arising out of the pandemic, including shifts by workers away from in-person jobs.
That still leaves wages growing well above levels that are compatible with the Fed’s 2% inflation target as employers raise pay to retain and hire workers in a tight jobs market, Summers, who is a paid contributor to Bloomberg Television, and Domash wrote.
Nick Bunker, head of economic research at Indeed Hiring Lab, also doubts wage growth can return to pre-pandemic levels with the labor market still so tight, especially for such service industries as leisure and hospitality.
While the post-lockdown hiring frenzy has ended, competition for workers is still “strong enough to keep wages growing at an elevated pace,” he said.
Citigroup Inc. global chief economist Nathan Sheets has flagged the potential for further catch-up spending on services such as travel that were depressed during the pandemic. He wrote in a Feb. 10 report that this should push up employment – and wages – in those labor-intensive sectors.
“The lion’s share of today’s inflationary pressures are arising from the services sectors, and this could create challenges for the central banks,” Sheets, a former Fed official, wrote.
He sees the US falling into recession in the second half of the year as the Fed raises rates three more times, by a quarter percentage point each.
Powell will have an opportunity of presenting his own latest take next week, with semiannual testimony on the economy before Congress.
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