Workers’ historic wage gains at risk in Fed’s inflation fight

Price spikes plague President Joe Biden’s economy even as the government releases a host of encouraging data, including a 4.5% increase in wages and salaries for American workers in 2021, the biggest since Ronald’s presidency Reagan. Yet those gains are being wiped out by rising costs everywhere from groceries to tanks of gas.

Still, if the Fed acts too aggressively, it could slow growth or even tip the economy into recession, which could hurt Democrats’ already slim chances of hanging on to Congress.

In interviews this week on Capitol Hill, Democratic lawmakers expressed cautious confidence in Fed Chairman Jerome Powell, who called high inflation a “serious threat” to the labor market and economic recovery.

“Hopefully they calibrate properly because they have a dual mandate,” Sen. Bob Menendez (DN.J.) said, emphasizing the Fed’s responsibility for full employment as well as price stability. “I can’t imagine you can continue with the type of interest rate that the Fed lends to, which is next to nothing.”

Said Sen. Brian Schatz (D-Hawaii), “I don’t want to put it in terms of worry, but yeah, it’s…the danger,” referring to a slowing economy. “But I’m not here to tell them how many basis points to raise rates. They won’t listen to me, and that’s not my job.

Sen. Jon Tester (D-Mont.) added, “I’m confident the Fed will gather all the information, synthesize it, and come up with the right approach.”

The Fed is expected to begin its rate-hike campaign next month, and markets now expect borrowing costs to rise by at least 1.5 percentage points by the end of the year, according to the CME FedWatch Tool – the equivalent of six quarterly rate hikes in points. The last time rates rose so much in a single year was in 2005, just before the peak of the housing boom.

But we do not yet know how far the Fed will go. The central bank still sees the possibility that inflation will begin to subside on its own as supply chain bottlenecks ease and congressional spending declines, according to the minutes of the meeting. its January rate-setting meeting released on Wednesday. If so, the Fed could raise rates from their ultra-low levels without needing to go much further and restrain the economy.

But if inflation requires more direct central bank intervention, the labor market will likely suffer, which could mean layoffs and pay cuts. In a more pessimistic scenario, the Fed could cause a recession.

“Once you’ve let the economy overheat, to really bring inflation down, you have to do something to reverse the gains in the labor market,” said Tim Duy, chief economist at SGH Macro Advisors and professor. at the University of Oregon.

While revenues grew rapidly last year, rising costs mean many people are left with no more money. Real wages, which are adjusted for inflation, fell 1.9% for private sector employees in 2021, according to the Labor Department.

Because of this dynamic, it is possible that the Fed could raise take home pay while slowing the overall pace of wage growth, as long as inflation is reduced by a larger amount.

The labor market itself is also strong, with labor shortages in some industries raising the possibility that the Fed could dampen labor demand without necessarily hurting those currently employed.

“There are several million more job openings than there are unemployed,” the Fed’s Powell told reporters last month. “There is quite a bit of room to raise interest rates without threatening the labor market.”

But if the Fed wants to fight inflation more aggressively, it will likely hurt wages and increase unemployment – ​​one reason the central bank has been more patient before taking action, allowing jobs to recover from the downturn. a blow at the start of the pandemic.

“If we are really honest, the main mechanism [to actively fight inflation] relies on the cooling of the labor market,” said Skanda Amarnath, executive director of the advocacy group Employ America. “That’s something people might find uncomfortable saying.”

For Fed policymakers, jolting the labor market to stifle high inflation might be useful, but more immediately their task is to remove their own support for economic growth by shifting rates from their levels. stockings that stimulate growth. If inflation and growth start to slow markedly this year, as many forecasters expect, the central bank won’t want to raise rates too aggressively and do too much.

“It’s pretty clear that we’re heading towards more traditional growth numbers,” said Omair Sharif, founder of Inflation Insights. “You are heading for a slowdown in inflation.”

Meanwhile, economists point out that the United States will need to make productivity gains to raise workers’ incomes in the long run. Biden bipartisan infrastructure bill should help with that, as will pandemic-related tech trends, but it’s too early to tell, said Jim Pethokoukis, economic policy analyst at the conservative American Enterprise Institute.

“If we’re going to have a productivity boom, we’re going to have a business investment boom. It would be a stat I would look very closely at in the years to come,” he said.

But more structural changes will also be needed, argued Erica Groshen, former chief of the Labor Department’s Bureau of Labor Statistics. She said less-educated workers often have important skills that are overlooked.

“Over the past 40 years, the real earnings of the median worker in the United States have been almost stagnant, even as productivity growth has increased,” Groshen said. “Reversing this trend will require tools that are not in the Federal Reserve’s toolbox.”

Rep. Don Beyer (D-Va.), who chairs the Joint Economic Committee of Congress, also said the Fed’s inflation-fighting mechanism is the short-term remedy, while chain adjustments d Supply and productivity improvements would have more lasting implications.

“I’m optimistic that wage gains will survive lower inflation,” he said. “We have plenty of time for the story to change” before the midterm elections.

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