Wages are still growing rapidly. The Fed wants them to slow down.

Madeleine Ngo covers economic policy for Vox. She previously worked at the New York Times, the Wall Street Journal, Bloomberg, and the Philadelphia Inquirer.

Paychecks have grown rapidly as businesses have struggled to deal with widespread labor shortages during the pandemic. As a result, firms have had to raise wages to attract and retain more workers, but that has also put pressure on inflation, since businesses have passed on some of those cost increases by raising prices for consumers.

Wage gains are starting to slow, though. While that might seem like bad news for workers, it could be an encouraging sign for Federal Reserve officials who have said they want to see growth return to a more sustainable level. Fed officials pay close attention to wages because strong growth could keep fueling inflation, eating into Americans’ real wage gains as many goods and services become more expensive and making it harder for the Fed to bring inflation back down to its 2 percent goal.

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

Historically, nominal wage growth has typically outpaced inflation by about a percentage point. But both wage growth and inflation are now much higher than normal. Even though paychecks have been growing rapidly, inflation has outpaced wage gains for many workers and real wage growth has been negative for nearly two years.

In December, average hourly earnings increased by 4.6 percent from the year before and 0.3 percent from the prior month. In comparison, wages grew at an average rate of about 5.1 percent in 2022. Average hourly earnings are calculated by dividing the total worker payroll by the total worker hours, meaning that they can reflect changes in wages and workforce composition.

Although inflation has started to slow in recent months, price increases have been outpacing wage gains for much of the pandemic. In December, prices rose 6.5 percent from the year before and declined 0.1 percent from the prior month, according to a Consumer Price Index report released last week. The slowdown in inflation last month was mainly driven by lower fuel, used cars, and airline fare costs.

Wage gains have been more rapid for certain workers, however. Paychecks have climbed the most for lower-skilled workers, for instance, according to data from the Federal Reserve Bank of Atlanta’s wage growth tracker. In December, wages rose 6.8 percent for low-skill workers compared to 6 percent for high-skill workers. Hourly workers also saw wages increase by 6.5 percent compared to 5.9 percent for non-hourly workers.

Slower wage growth could reduce pressure on prices

A slowdown in pay gains could help ease inflation because businesses’ operating costs wouldn’t be as high, meaning that employers might not feel as much of a need to raise consumer prices or be more likely to offset costs in other ways, said Kathy Bostjancic, the chief economist at Nationwide. That’s especially true for businesses that offer services, since worker compensation is a major cost. Slower wage growth could also cool consumer demand since workers would not have as much income to spend.

Bostjancic said she expected to see wage growth gradually slow throughout the year as the demand for workers falls, although she noted there are some reasons to believe that wage gains could be persistent. The labor market is extremely tight, and even though hiring has started to decelerate, employers continue to add hundreds of thousands of jobs to the economy each month. The unemployment rate also stands at 3.5 percent, a half-century low.

“You’re still seeing the lack of skilled labor remain an issue for companies,” Bostjancic said.

Fed officials generally see wage growth as a potential driver and signal of overall inflation, making those gains important to watch since they could influence how aggressively the Fed raises interest rates, said Aaron Sojourner, a labor economist and senior researcher at the W.E. Upjohn Institute for Employment Research.

The Fed started hiking interest rates early last year, which has made borrowing money and doing things like taking out a mortgage more expensive. The Fed is trying to curb consumer demand, which should eventually lead to slower price increases. But policymakers face a difficult task — by slowing the economy to rein in inflation, the Fed risks going too far and causing an unnecessarily painful surge in unemployment. Businesses could respond to higher interest rates and slower demand by reducing hiring or laying off workers.

The central bank has raised rates aggressively, only recently pulling back by lifting rates by half a percentage point in December after several straight three-quarter-point increases. Economic forecasters expect the Fed to raise rates by an even smaller quarter percentage point at the central bank’s next meeting at the end of the month.

“I think the Fed isn’t sure and is skeptical of the idea that wages can rise much faster than broad prices for a long time,” Sojourner said. “The Fed wants to see the growth rate of wages coming down.”

As the broader labor market cools, wage growth has slowed. Julia Pollak, the chief economist at ZipRecruiter, said wage growth was faster earlier in the pandemic for several reasons. Workers needed to be compensated more for the health risk of working in manual services or working in person, she said. Employers also needed to raise pay and expand benefits when there were fewer available workers because of school closures and limited access to public transportation.

And even though inflation has been outpacing average hourly earnings on an annual basis, some economists note that monthly data shows that price growth has been slower than or similar to wage growth recently.

“That is likely to continue and that effect actually could get bigger because we are seeing inflation coming down pretty rapidly,” Pollak said.

Many economists are predicting that inflation will continue to slow in the coming months after potentially peaking at 9.1 percent in June. That’s in part because supply chains have started to heal, easing pressure on goods prices. Private data sources have also found that rent prices for new leases have already started to drop. Because changes in rent prices tend to show up in the government data with a lag, economists are expecting to see a greater slowdown in shelter cost increases in the coming months.

Vincent Reinhart, the chief economist and macro strategist at Dreyfus and Mellon, said that if inflation slowed to around 3 percent by the end of the year, he would expect average hourly earnings to return to a more sustainable rate of around 3.5 percent on an annual basis. But Reinhart, a former Fed economist, also noted that the unemployment rate was extremely low and there were nearly twice as many job openings as there were unemployed people.

“There should be a lot of pressure on wages,” Reinhart said. “They can’t take it as given that just because the last couple of months were favorable, underlying conditions are favorable.”

Sourse: vox.com