The Federal Reserve seeks to rein in inflation by slowing wage growth

Paychecks grew rapidly as companies struggled to deal with widespread labor shortages during the pandemic. As a result, companies had to raise wages to attract and retain more workers, but this also put pressure on inflation, since companies missed out on some of these cost increases by raising prices for consumers.

However, wage gains are starting to slow. While this may sound like bad news for workers, it could be an encouraging sign for Fed officials who have said they want to see growth return to a more sustainable level. Fed officials are paying close attention to wages because strong growth could continue to fuel inflation, undermining real wage gains for Americans as many goods and services become more expensive and making it more difficult for the Fed to bring inflation down to its 2 percent target.

“We want strong wage increases,” Federal Reserve Chairman Jerome Powell said at a press conference in December. “We just want it to be at a level commensurate with 2 percent inflation.”

Historically, nominal wage growth has outpaced the inflation rate by about a percentage point. But wage growth and inflation are now much higher than usual. Although paychecks were growing rapidly, inflation outpaced wage gains for many workers and real wage growth has been negative for nearly two years.

In December, average hourly earnings increased 4.6 percent from a year earlier and 0.3 percent from the previous month. By comparison, wages grew at an average rate of about 5.1 percent in 2022. Average hourly wages are calculated by dividing workers’ total salaries by total hours worked, which means they can reflect changes in wages and the composition of the workforce.

Wage growth has begun to slow

Although inflation has begun to slow in recent months, price increases have outpaced wage gains for most of the pandemic. In December, prices rose 6.5 percent from a year earlier and fell 0.1 percent from the previous month, according to the Consumer Price Index report released last week. The slowdown in inflation last month was mainly driven by declines in fuel, used car and airfare costs.

However, wage gains have been faster for some workers. Paychecks have climbed the most for low-skilled workers, for example, according to data from the Federal Reserve Bank of Atlanta’s wage growth tracker. In December, wages rose 6.8% for low-skilled workers compared to 6% for highly skilled workers. Hourly workers also saw a wage increase of 6.5 percent compared to 5.9 percent for non-hourly workers.

Slowing wage growth could reduce pressure on prices

Cathy Bostancic said a slowdown in wage gains could help mitigate inflation because businesses’ operating costs wouldn’t be as high, meaning employers might not feel the need to raise consumer prices or be more likely to offset costs in other ways. , chief economist at Nationwide. This is especially true for companies that provide services, because workers’ compensation is a significant expense. Slowing wage growth could also cool consumer demand because workers won’t have as much income to spend.

Bostancic said she expects to see wage growth gradually slow throughout the year as demand for workers declines, though she noted there is some reason to believe wage gains could continue. The job market is very tight, and even though hiring has begun to slow, employers continue to add hundreds of thousands of jobs to the economy each month. The unemployment rate is also at 3.5%, its lowest level in half a century.

“You still see that skilled labor shortage continues to be an issue for companies,” Bostancic said.

Fed officials generally see wage growth as a potential driver and signal of headline inflation, making these gains important to watch because they can influence how aggressively the Fed raises rates, Aaron Sojourner, labor economist and senior research fellow at the WE Upjohn Institute, told Xinhua. Employment research.

The Fed started raising interest rates early last year, which made it more expensive to borrow money and do things like take out a mortgage. The Fed is trying to curb consumer demand, which should eventually slow price increases. But policymakers face a difficult task — by slowing the economy to rein in inflation, the Fed risks going too far and causing an unnecessary painful increase in unemployment. Companies can respond to higher interest rates and slower demand by hiring less or laying off workers.

The central bank has raised interest rates dramatically, only recently backtracking by raising interest rates by half a percentage point in December after several consecutive three-quarter point increases. Economic forecasters expect the Fed to raise interest rates by a smaller quarter of a percentage point at the next central bank meeting at the end of the month.

“I think the Fed is not sure and doubts the idea that wages can rise much faster than general prices for an extended period,” Sojourner said. “The Fed wants to see the rate of wage growth come down.”

As the broader labor market slows, so does wage growth. Wage growth was faster earlier in the pandemic for several reasons, said Julia Pollack, chief economist at ZipRecruiter. She said workers need greater compensation for the health risks of working in manual services or working in person. Employers also needed to increase wages and expand benefits when there are fewer workers available due to school closures and limited access to public transportation.

And although inflation has outpaced average hourly earnings on an annual basis, some economists point out that monthly data shows price growth has been slower or similar to wage growth recently.

“This is likely to continue and this effect may actually increase because we see inflation coming down so quickly,” Pollack said.

Many economists expect inflation to continue to slow in the coming months after peaking at 9.1% in June. This is partly because supply chains have begun to recover, easing pressure on commodity prices. Private data sources also found that rental rates for new leases have already begun to fall. Since changes in rental prices tend to show up in government data with a lag, economists expect to see a further slowdown in shelter cost increases in the coming months.

Vincent Reinhart, chief economist and macro strategist at Dreyfus and Mellon, said that if inflation slows to around 3 percent by the end of the year, he expects average hourly earnings to return to a more sustainable rate of about 3.5 percent annually. Basis. But Reinhart, a former Fed economist, also noted that the unemployment rate was very low and there were nearly twice as many jobs available for the unemployed.

“There has to be a lot of pressure on wages,” Reinhart said. “They can’t take it just because the last two months have been favorable, the underlying conditions are favorable.”

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