The Fed Should Wait For Wages To Rise

Isaiah J. Poole

The Federal Reserves Open Market Committee started a two-day series of meeting today, and on Wednesday Fed Chair Janet Yellen is expected to announce the latest verdict on if, and perhaps when, interest rates will begin to rise.

The conventional wisdom is that as the unemployment rate has neared 5 percent, the time is fast approaching for the nation’s unprecedented period of near-zero interest rates to end.

But Josh Bivens, economist at the Center for Budget and Policy Priorities, writes this week that the unemployment rate is the wrong number to watch. Instead, the Fed should be looking at wages.

As Bivens notes, the compelling reason to raise interest rates is to make sure that inflation does not get out of control. That happens, economic theory goes, when unemployment falls below its “natural rate” – the level at which there is a rough equilibrium between demand for work and the supply of willing workers. If there is a greater demand for workers than there are workers to meet the demand, workers are in a better position to demand higher wages for their work.

Bivens argues that it would be wrong to raise interest rates to slow down the economy and prevent that from happening.

That’s why, he writes, that policymakers at the Fed should be looking at wage inflation, not the unemployment rate, when deciding whether to raise interest rates. If they used that measure, an interest rate rise in 2015 would be out of the question.

“If the trend in productivity growth is fairly stable, then fairly precise wage targets can be estimated,” he writes. “Specifically, for a 2 percent price inflation target, 1.5 percent trend productivity growth is consistent with nominal wage growth of 3.5 percent. Since the recovery from the Great Recession began, however, nominal wage growth has stayed well under 2.5 percent and shows few signs of accelerating.”

In fact, because wage growth has been so sluggish, he writes that “policymakers may even want to allow real (i.e., inflation-adjusted) wage growth to exceed productivity growth for an extended, albeit temporary, period to allow normalization of the labor share of income, which has fallen precipitously since recovery from the Great Recession began in mid-2009. A period of real wage growth exceeding productivity growth is actually a normal phase of recovery.”

Low interest rates are often compared to the punch bowl at a big financial party. Certainly keeping rates near zero has been a boon for Wall Street, which has been able to take advantage of the rates to borrow cheaply and boost their stock prices. But the Fed raising interest rates too soon would be akin to taking the punch bowl away before Main Street workers have had an opportunity to get a good sip. Yellen has indicated that she realizes that is unfair. The question is whether she will hold firm against the austerity mavens and inflation hawks who are terrified that empowered workers will demand more than the stagnant wages they now receive. What we can’t afford is an action that would end the recovery before workers have had a chance to recover.

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