April 02, 2016
The NYT article on the March jobs report featured several economists describing the current state of the economy in glowing terms. Scott Clemons, chief investment strategist at Brown Brothers Harriman, described the current economic situation as being a “near Goldlocks scenario.” He said the jobs and wage gains in March were healthy, but not so strong as to prompt the Federal Reserve Board to raise interest rates to slow growth.
Michelle Meyer, deputy head of United States economics at Bank of America Merrill Lynch, described the economic situation as “a best-case scenario.” Michael Gapen, chief United States economist at Barclays, also was very positive about the economy. This view seemed to be reflected in the first two paragraphs in the article which were also overwhelmingly positive about the current state of the economy.
(In fairness, the piece included several comments noting how far the economy has yet to go to recover to pre-recession levels. Also, in addition to the optimism from the bank economists, it included a comment from Claire McKenna, a senior policy analyst with the National Employment Law Project.)
While there is little doubt that the economy is doing much better in recent months than it had been earlier in the recovery and that workers are seeing some gains, it is important to ask about the implicit base of comparison in these comments.
The average hourly wage increased at a 2.3 percent rate over the last year. Its annualized rate of increase over the last three months compared with the prior three months is also 2.3 percent, which indicates no acceleration. Since inflation over the last year was only 1.0 percent, this translates into a 1.3 percent increase in real wages over this period. While this is a decent rate of increase, it is only roughly equal to the trend rate of productivity growth. In other words, this is the rate of wage growth that workers should be able to assume in a normal year.
However, there are two reasons to consider this rate inadequate. First, workers lost an enormous amount of ground in the downturn. The average real hourly wage did not pass its 2008 peak until November of 2014. (Workers had also seen almost no wage growth in the prior business cycle, so they had lots of ground to make up even in 2008.)
Much of this loss was due to a redistribution from wages to corporate profits. Roughly half of this redistribution has been reversed in the last two years, but there is still a substantial distance to go to make up the lost ground in full. This means that we should expect wage growth to exceed productivity growth for a period of time, if workers are to make up the lost ground. (There is a question as to trend productivity growth, with actual growth being incredibly low in real years. Some of us see that as partially endogenous, but we’ll leave that for another day.)
The other reason for questioning the adequacy of the current pace of wage growth is that the real wage growth over the last year is almost entirely the result of falling energy prices. The core rate of inflation (excluding food and energy prices) in the last twelve months has been 2.3 percent, the same as the rate of wage growth.
Virtually no one expects energy prices to keep falling at the same pace, and in fact they have been rising in the last month. We then have to ask what happens to wage growth in a context where the overall inflation rate is closer to 2.0 percent. If the Fed acts to keep wage growth from accelerating by raising interest rates to slow the pace of job growth, then real wage growth will then be held to near zero, with workers getting almost none of the gains from economic growth.
This raises the point that the Fed’s decisions about slowing the economy are not fixed in stone, but rather a matter subject to debate. While some economists may be comfortable with a Fed that acts to prevent wage growth in order to prevent any possible risk of inflation, much of the public would probably not share this perspective.
Whether or not the Fed moves to slow the economy if job growth continues on its current path is an issue that should be a major topic of public debate. In the presidential campaign all the candidates have made promises about creating jobs. If they face a Federal Reserve Board that is determined not to allow for more jobs and a lower rate of unemployment, due to its concerns about inflation, these candidates will not be able to carry through on their commitments, even assuming their plans otherwise would lead to growth.
For this reason it is important the Fed’s decisions on interest rates feature prominently in public debates on economic policy. And it should be clear that the Fed is never forced to raise rates, it does so because it chooses.
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