Should the Fed give workers a raise? No
By Scott Sumner
After many years of 2% wage growth, nominal average hourly earnings are finally accelerating, up to 2.8% in October (year over year). This reflects the fact that the (downward) wage adjustments in the wake of the Great Recession are over, and the economy is near the natural rate. (Unemployment is 4.9%, while the broader U-6 rate just fell to 9.5%, lowest since April 2008.)
Some people are saying the Fed should give the economy “more room to run”. They shouldn’t be a bunch of meanies who are tightening policy just when workers are finally getting a raise. I certainly don’t want the Fed to be a meanie, but the 2.8% nominal wage growth is actually the strongest argument for a rate increase—even stronger than the low unemployment.
Most people confuse nominal wages with real wages. The Fed controls nominal wages, but what matters to workers (in terms of living standards) is real wages. If the Fed were to try to raise real hourly earnings with an easy money policy, it would fail. And the reason is blindingly obvious. Yes, easy money would boost wage growth, but it would also boost inflation.
Could you argue that the wage growth would occur first, and then the inflation? Sure, you can argue anything, but it’s not true. Wages are sticky, and tend to be a lagging indicator. So no, the Fed has no power to increase real hourly wages, at least over any extended period of time.
Of course they might briefly raise real wages by suddenly tanking the economy through tight money. That would depress commodity prices, and the CPI inflation rate would quickly fall well below the (sticky) wage inflation rate. That’s exactly what happened in 2009—how’d that work out for America’s workers?
A better argument for easy money is that the economy still has slack, and that while faster growth would not boost real hourly wages, it would boost total wage compensation, by increasing hours worked. But the rising wage inflation rate suggests that there is not much slack left in the economy. Maybe a little, but not very much.
An even better argument for easy money is that the Fed has been undershooting its inflation objective, and TIPS spreads suggest it will continue doing so. On the other hand TIPS spreads may be biased, and both the Fed and private sector forecasters expect roughly 2% inflation going forward.
The reason that 2.8% wage growth is the single best argument for tightening is that the Fed seems committed to roughly 3% NGDP growth as a long-term trend. In my view, that implies roughly 2.4% hourly wage growth as a long run equilibrium, and about 0.6% growth in hours worked per year. Thus the recent numbers are actually above the new average (if I’m correct.) It looks to me like the Fed is going back to its old game plan—procyclical monetary policy.
Just to be clear, as long as the Fed is doing inflation rate targeting (not level targeting) I believe a 3% NGDP trend is too low. It will leave the Fed poorly prepared for the next recession. They should either switch to NGDP level targeting, or raise their inflation target. But if they insist on staying with the current target, then it would be a huge mistake to try to “give workers a raise”. It would not even do what the proponents hope for, and it would destabilize the economy.
When commenters try to characterize my monetary policy views, they almost always get it wrong. That may be partly because I’m a poor communicator, but I suspect it’s also because most people think in simplistic terms, along a linear hawkish/dovish scale. That’s not how I approach monetary policy. I think in terms of regimes, not whether the Fed is too easy or too tight at the moment. Based on their preferred regime they are probably about right. Based on my preferred growth rate regime they are too tight. Based on my preferred level targeting regime they are about right. All statements about monetary policy must be viewed in context.
Here’s analogy. Is someone driving west on I-94 past Kalamazoo, Michigan going in the right direction? Well, it depends on whether they hope to end up in Chicago or in Detroit.