Federal Reserve seeks to curb inflation with slower wage growth

Paychecks have grown rapidly as businesses have struggled to cope with widespread labor shortages during the pandemic. As a result, companies have to raise wages to attract and retain more workers, but this also leads to inflation, as businesses have absorbed some of these cost increases by raising prices for consumers.

Wage gains are starting to slow, though. While that may seem like bad news for workers, it could be an encouraging sign for Federal Reserve officials who say they want to see growth return to more sustainable levels. Fed officials are paying attention to wages because strong growth could continue to push up inflation, eating into America’s real wage gains as many goods and services become more expensive and making it harder for the Fed to bring inflation back to its 2 percent target.

“We want strong wage increases,” Fed Chairman Jerome Powell said at a press conference in December. “We just want them to be at a level consistent with 2 percent inflation.”

Historically, nominal wage growth has typically outpaced inflation by about a percentage point. But wage growth and inflation are now higher than normal. Although wages have grown rapidly, inflation has outstripped wage gains for many workers and real wage growth has been negative for nearly two years.

In December, average hourly earnings increased 4.6 percent from the previous year and 0.3 percent from the previous month. In comparison, wages are expected to increase by an average of 5.1 percent in 2022. Average hourly earnings are calculated by dividing an employee’s salary by total hours worked, meaning they can reflect changes in wages and the composition of the workforce.

Although inflation has started to slow in recent months, price increases have outpaced wage gains for much of the pandemic. In December, prices rose 6.5 percent from the previous year and declined 0.1 percent from the previous month, according to the Consumer Price Index report released last week. Last month’s decline in inflation was mainly driven by cheaper fuel, used cars, and airline fares.

However, wages rise faster for certain workers. Paychecks have risen the most for lower-skilled workers, for example, according to data from the Federal Reserve Bank of Atlanta’s wage growth tracker. In December, wages rose 6.8 percent for low-skilled workers compared to 6 percent for high-skilled workers. Hourly workers also saw their wages increase by 6.5 percent compared to 5.9 percent for non-hourly workers.

Slower wage growth could ease pressure on prices

Lower wages can help reduce inflation because business operating costs aren’t as high, meaning employers don’t need to raise consumer prices or are more likely to offset costs in other ways, Kathy Bostjancic said. , chief economist at Nationwide. This is especially true for businesses that offer services, as workers’ compensation is a major expense. Slower wage growth could also weigh on consumer demand as workers don’t have as much income.

Bostjancic said he expected wage growth to slow over the course of the year as demand for workers eased, though he noted there were few reasons to believe wage gains could continue. The labor market is tough, and even though hiring has started to shrink, employers continue to add hundreds of thousands of jobs to the economy each month. The unemployment rate is also at 3.5 percent, a half-century low.

“You still see the lack of skilled labor remains a problem for companies,” Bostjancic said.

Fed officials generally view wage growth as a potential driver and signal of overall inflation, which makes the gains important to watch because they could influence how aggressively the Fed raises interest rates, said Aaron Sojourner, a labor economist and senior researcher at the WE Upjohn Institute for Employment Research.

The Fed started raising interest rates early last year, which made borrowing and doing things like taking out a mortgage more expensive. The Fed is trying to curb consumer demand, which will ultimately lead to slower price increases. But policymakers face a difficult task – by slowing the economy to curb inflation, the Fed risks going too far and causing an unnecessary rise in unemployment. Businesses can respond to higher interest rates and slower demand by reducing hiring or laying off employees.

The central bank has been raising rates aggressively, only recently pulling back by lifting rates by half a percent in December after three straight quarters of hikes. Economists expect the Fed to raise rates by a smaller quarter percentage point at the central bank’s next meeting at the end of the month.

“I think the Fed is not convinced and is not convinced that wages can rise faster than long-term prices,” Sojourner said. “The Fed wants to see the growth rate of wages go down.”

As the broader labor market did, wage growth slowed. Julia Pollak, chief economist at ZipRecruiter, said wage growth was faster before the pandemic for a number of reasons. Workers should be compensated more for the health risks of working in manual services or working privately, he said. Employers will also need to raise wages and expand benefits when there is a shortage of workers due to school closures and access to public transportation.

And although inflation has outstripped average hourly earnings every year, some economists note that monthly data shows that price growth has been slower than or equal to wage growth recently.

“This is likely to continue and the effect could be magnified as we see inflation come down quickly,” Pollak said.

Many economists predict that inflation will continue to slow in the coming months after peaking at 9.1 percent in June. Partly because supply chains have begun to recover, easing pressure on commodity prices. Private data sources also found that rental prices for new rentals have started to fall. Because changes in rent prices tend to show up in government data with a lag, economists expect shelter costs to rise in the coming months.

Vincent Reinhart, chief economist and macro strategist at Dreyfus and Mellon, said that if inflation eases to about 3 percent by the end of the year, he would expect average hourly earnings to return to a more sustainable level of about 3.5 percent annually. basic. But Reinhart, a former Fed economist, also noted that the unemployment rate is very low and that there are nearly twice as many job openings as unemployed people.

“There should be a lot of pressure on wages,” Reinhart said. “They can’t take it for granted just because the last few months have been good, the basic situation is better.”