Should the Fed be worried about wage inflation?

By Felix Salmon
May 19, 2011
Kathleen Madigan blogs -- without linking to -- the latest FOMC minutes, and picks up on an important point: the Fed is keeping rates low largely because it sees little risk of wage inflation.

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Kathleen Madigan blogs — without linking to — the latest FOMC minutes, and picks up on an important point: the Fed is keeping rates low largely because it sees little risk of wage inflation. If and when wages pick up, the Fed isn’t particularly worried about inflation. “But if wages pick up,” she writes, “the Fed may step in.”

Mark Thoma is unimpressed by this: “We are much too worried about a wage-price inflation cycle breaking out and causing problems,” he says. “If the Fed is too trigger happy, it could snuff out the recovery it is hoping to bring about.”

There’s a good reason to be sanguine about rising wages, and that’s rising food and energy prices. The Fed prefers to look at core inflation when setting monetary policy, on the grounds that food and energy prices are too volatile for it to be able to control, or tend to be cyclical. But they loom large for Americans when it comes to the cost of living, and wage increases are needed to pay for higher grocery bills and more-expensive tanks of gas.

John Kemp does a good job of explaining why the Fed should look at headline rather than core inflation. But at the same time, it probably should keep an eye on wages as well. After all, wages are pretty much the one thing which wasn’t hurt by the recession:

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To put this in terms even a politician can understand, the average weekly paycheck is now $787.19. That’s $59.78, or 8.2%, higher than it was at this point four years ago — and the rate of increase in wages is not slowing down. If you have a job at the next election day, you’ll likely be earning between 8% and 10% more than you were when Barack Obama was elected. This country has many problems, unemployment first and foremost among them, but stagnant wages and employees being underpaid are pretty low down the list, if they’re on it at all.

I do think that productivity gains should go more to labor and less to capital, but in the first instance that should take the form of increased hiring, rather than wage increases for the already-employed. Those of us with jobs are the fortunate ones — and yes, if we’re paid more, we’ll spend more, and that in turn is likely to show up in higher prices. The Fed is probably right to be worried about wage inflation. But that just means that it should look for ways to divert that money into new hiring, rather than raising rates to choke it off altogether.

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