Buried in Friday’s rather middling December jobs report was a small ray of light: Hourly wage increases are finally starting to gain speed after four years of steady deceleration. That’s not to say wages have been declining, just that their pace of increase has slowed steadily.
In December 2008, hourly earnings for production and nonsupervisory workers were growing at 4 percent a year. That rate fell to 1.3 percent by July and flatlined through most of the fall. But in December it jumped to 1.7 percent. That might not sound like a lot, but it’s the biggest monthly gain since the recovery began in June 2009.
That’s good news for workers, though it could spell trouble for the Federal Reserve’s loose monetary policy. Declining wage growth has been the “Fed’s best friend” in its continued argument that it can keep interest rates near zero without triggering inflation, says James Paulsen, chief investment strategist at Wells Capital Management. While it’s only a couple of months of data, history suggests that wages may have bottomed and will continue to pick up speed. Since 1980, wage growth typically has begun to accelerate three to four years into an economic recovery, eventually goosing broader inflation. “If the last 30 years is any guide, this carefree monetary window may be closing much sooner than widely anticipated,” Paulsen wrote to clients in a Jan. 4 note.
The idea to close it sooner rather than later is apparently gaining adherents among Fed officials. According to minutes of its Dec. 11-12 meeting, as reported by Bloomberg, “several members” of the Federal Open Markets Committee want to slow or stop the central bank’s bond-buying program (known as quantitative easing) before the end of 2013. That came as a surprise to many, considering that at the same meeting, Chairman Ben Bernanke was able to gain almost unanimous support for a plan to escalate the central bank’s stimulus efforts by pledging to keep interest rates near zero as long as the unemployment rate stays above 6.5 percent and inflation remains in check.
Wage growth is typically one of the first drivers of broader inflation. If wages continue growing, yet the unemployment rate remains above 6.5 percent, that could put the Fed in a box.
“We’re really at a crossroads in Fed policy,” says Julia Coronado, chief economist at BNP Paribas (BNP). The Fed wants to reduce the unemployment rate through strong gross domestic product growth and increased hiring that pulls people back into the workforce. But that’s not what’s been happening lately. The decline in the unemployment rate owes as much to people dropping out of the labor force as it does to strong growth and robust hiring. The smaller the workforce, the fewer jobs needed to reduce unemployment. “That’s not the way they want to get there,” says Coronado.
Which is why wage growth is so crucial. If wages pick up and begin driving inflation higher, but growth remains tepid, “you might have to concede the economy’s growth potential is permanently lower,” says Coronado. Not exactly what Bernanke wants to hear.
