Many Americans remember the 2007-2009 Great Recession’s impact on the U.S. labor market. Decimated by the fallout from the subprime mortgage crisis, between 2008-2009, the economy lost an average of 360,000 jobs/month. In October 2009, the unemployment rate peaked at 10 percent, and it wasn’t until late 2014 the rate fell below 6 percent.
The labor market continues to steadily improve. In April, the economy added 164,000 new non-farm jobs, slightly below the 191,000 expected. But the economy is averaging 200,000 new jobs a month this year, above the monthly average for both 2016 and 2017. The unemployment rate fell to a 17-year low of 3.9 percent. Next year, the rate should further decline to just 3.6 percent, a level not reached since 1969.
Despite the continuing surge in the labor market, employee wage growth has been stubbornly modest. For the third consecutive month, wages in April grew at an annual pace of 2.6 percent, in-line with its two-year average. In a healthy economy, the rate of wage growth should be around 3-3.5 percent. But employees haven’t seen a full year of 3-plus percent wage growth in nearly a decade.
Yes, rising wages benefit consumers, whose spending is the key driver of the American economy. But wage growth poses a significant dilemma for the Federal Reserve. Wages rising too fast stokes inflation, the year-over-year increase in prices for goods and services. More importantly, it forces the Fed to enact interest rate hikes. These hikes, in effect, gently tap the breaks on economic growth by increasing the cost of borrowing, which helps keep rising inflation in check.
Since December 2015, the Fed has implemented six 0.25 percent rate hikes to the benchmark fed funds rate, upon which short-term debt is often based. At a minimum, five more 0.25 percent hikes are expected by the end of 2019.
The significance of the 2.6 percent wage growth in February-April matching the two-year average is that it now appears January’s 2.8 percent spike was more of a one-off blip. If you recall, January’s spike in reported wage growth on February 2 sent a tremor through the markets that inflation was starting to accelerate. Concerns the Fed would become more aggressive raising interest rates sent the Dow Jones Industrial Average plummeting. In the following six days, the Dow sank a massive 2,326 points, or 8.9 percent.
The slow-down in wage growth may have tempered some concerns over rising inflation but certainly hasn’t eliminated them.
The core Personal Consumption Expenditures Index is the Fed’s preferred method of tracking inflation. It measures the annualized change in prices paid by consumer households for goods and services, excluding the more volatile and seasonal food and energy prices. The latest core PCE indicates the inflation rate jumped from 1.6 percent to 1.9 percent in the past month, approaching the Fed’s target inflation rate of 2 percent.
The Fed judges that a 2 percent inflation rate, over the long-term, is the ideal healthy balance between price stability and economic growth. The challenge, however, is trying to keep the rate of inflation from surging past this target. If necessary, the Fed would impose additional rate hikes to help keep this rate near 2 percent.
There is much debate, even within the Fed, as to why wages haven’t been rising at a faster pace. Traditional economic theory states that as the unemployment rate declines, businesses must compete for a declining pool of skilled workers, which drives wages higher. Despite a 17-year low unemployment rate, wage growth hasn’t changed much in the past two years.
Yes, the economic relationship between wage growth, the unemployment rate and inflation can be quite complex. But for the American worker, the question is very simple and understandable — when will higher wage growth finally kick in?