Getty Images Is inflation galloping higher? And are rising wages the spur? The leader of the U.S. central bank and some prominent Wall Street economists are skeptical.
Here’s a little bit of economy heresy: Forget about how many jobs the U.S. is creating or even the nation’s amazingly low and still falling 3.9% unemployment rate.
What’s going to dictate whether the U.S. enters a recession in the next few years is how high inflation goes and to what extent rising worker pay fuels the fire.
The focus on wages takes center stage again on Friday when the government issues employment figures for August. The U.S. likely added 168,000 new jobs and the unemployment rate may have fallen a tick to 3.8%, according to the MarketWatch forecast of economists.
What Wall Street DJIA, -0.75% really wants to know is whether worker pay increases again. Higher pay has long been linked to rising inflation and is generally viewed by investors as a sign of upward price pressures.
Make no mistake. Both inflation and wages have risen over the past few years from unusually low levels.
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The Federal Reserve’s preferred PCE inflation gauge, for example, has risen to a 2.2% yearly rate from almost zero just a few years ago. It now sits slightly above the central bank’s comfort zone of 2% and is at a nearly six-year high.
The increase in the typical worker’s hourly pay, meanwhile, climbed to a nine-year-high of 2.9% in the 12 months ended in August. By contrast, hourly pay rose 2% a year or less from 2010 to 2015.
There’s a good chance wage growth will ease slightly in September to 2.8% due to seasonal oddities, economists say, but it’s unlikely to last. Other measures of wages and worker compensation have also surged.
Just yesterday, the leading lobby group for small businesses said a record number of owners have raised compensation to attract workers in a very tight labor market. Big businesses such as AMZN, -2.22% ace the same pressure to boost wages. The internet giant says it will raise starting pay for all its workers to $15 an hour.
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If prices and wages both keep climbing, the Federal Reserve is set to keep lifting U.S. interest rates to snuff out any dangerous whiffs of inflation. Historically cycles of rising rates have eventually led to recession.
It’s by no means certain, however, that inflation will keep going up. Nor is it clear that rising wages will be the driving force.
The Fed’s first-year chairman, Jerome Powell, suggested in a major speech in August that low unemployment was not always a guarantee of higher inflation. He pointed to period of low and stable inflation in the late 1990s when unemployment last dipped below 4%.
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Building on that theme, Powell on Wednesday followed up with another defense of his “gradualist” approach to raising U.S. interest rates.
“Higher wage growth alone need not be inflationary,” he said in speech in Boston. “The late 1990s episode of low unemployment saw wages rise faster than inflation plus productivity growth without an appreciable rise in inflation.”
Some prominent Wall Street economists are also skeptical rising wages will spur inflation into a gallop.
Joseph Lavorgna, chief Americas economist at Natixis and the former chief economist at Deutsche Bank, questioned the link between wages and inflation.
Can someone tell me the last time that higher wages caused #inflation? I seriously want to know.
— Joseph A. LaVorgna (@Lavorgnanomics) October 2, 2018
This debate won’t get settled soon. While wages and inflation have historically moved in the same direction over time, they sometimes have shown a big divergence. Like they did in the 1990s.
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Powell is banking on a similar divergence now.
He’s prepared to raise U.S. interest rates as high as needed to prevent inflation, but he wants to go slowly. He wants to see clear evidence of inflation careening toward 3% or more before adopting a more traditional strategy that has usually ended up putting the economy in the dumps.
