By VICTORIA GUIDA, February 17, 2022
American wages are surging at the fastest clip since 1983, driven by a booming economy and intense competition for workers. Now, that momentum is in danger of being crushed as the Federal Reserve faces mounting pressure to fight an all-out war against inflation.
The spike in consumer prices has fueled market expectations in recent days that the Fed will accelerate its plans to hike interest rates to slow down the economy. That has increased concern among labor advocates and other Democratic Party allies that the central bank might undercut the once-in-a-generation job market before workers have the chance to enjoy its benefits.
“I’m definitely worried,” said Josh Bivens, director of research at the Economic Policy Institute, a research group affiliated with the labor movement. “I’m worried before the end of the year we could’ve turned out to have hit the brakes too hard.”
Calls for the Fed to act quickly to raise rates from their historically low levels have reached a fever pitch following last week’s report that inflation jumped 7.5 percent over the last year, a four-decade high. Sen. Joe Manchin (D-W.Va.) told reporters the central bank needs to “stop pussyfooting around,” and analysts ramped up their forecasts for how much rates would rise in 2022.
The price spikes are plaguing President Joe Biden’s economy even as the government churns out a slew of encouraging data, including a 4.5 percent increase in wages and salaries for U.S. workers in 2021, the biggest since Ronald Reagan’s presidency. Yet those gains are being wiped out by rising costs everywhere from the grocery store to the gas tank.
Still, if the Fed acts too aggressively, it could slow down growth or even tip the economy into recession, potentially dooming Democrats’ already slim chances of holding on to Congress.
In interviews this week on Capitol Hill, Democratic lawmakers expressed guarded faith in Fed Chair Jerome Powell, who has called high inflation a “severe threat” to the job market and the economic recovery.
“I hope that they will calibrate correctly because they have a dual mandate,” said Sen. Bob Menendez (D-N.J.), stressing the Fed’s responsibility for full employment as well as price stability. “I cannot imagine you can go continuously with the type of interest rates that the Fed is lending at, which is virtually nothing.”
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Said Sen. Brian Schatz (D-Hawaii), “I don’t want to express it in terms of worry, but yeah that’s … the danger,” referring to a slowing economy. “But I’m not here to tell them how many basis points to raise rates. They’re not going to listen to me, and it’s not my job.”
Added Sen. Jon Tester (D-Mont.), “I have confidence that the Fed will take in all the information and synthesize it and come out with the right approach.”
The Fed is likely to begin its rate-hike campaign next month, and markets are now expecting at least a 1.5-percentage-point increase in borrowing costs by the end of the year, according to the CME FedWatch Tool — the equivalent of six quarter-point rate hikes. The last time rates rose that much in a single year was in 2005, just before the peak of the housing boom.
But it’s not clear yet how far the Fed will go. The central bank still sees a possibility that inflation could begin to cool on its own as supply chain bottlenecks ease and congressional spending fades, according to minutes from its January rate-setting meeting released Wednesday. If that’s the case, the Fed could lift rates from their ultra-low levels without needing to go much further and restrict the economy.
But if inflation needs more direct intervention by the central bank, 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 get inflation back down, then you have to do something to reverse the gains in the job market,” said Tim Duy, chief economist at SGH Macro Advisors and a professor at the University of Oregon.
While incomes grew rapidly last year, rising costs mean many people aren’t actually ending up with more money. Real wages, which are adjusted for inflation, dropped 1.9 percent for private-sector employees in 2021, according to the Labor Department.
Because of that dynamic, it’s possible that the Fed could increase take-home pay while lowering the overall pace of wage growth, as long as inflation is reduced by a larger amount.
The job market itself is also strong, with worker shortages in some industries, raising the possibility that the Fed could dampen demand for labor without necessarily hurting those currently employed.
“There are many millions of more job openings than there are unemployed people,” the Fed’s Powell told reporters last month. “There’s quite a bit of room to raise interest rates without threatening the labor market.”
But if the Fed wants to more aggressively take on inflation, it will likely hurt wages and increase unemployment — one reason the central bank has been more patient before acting, allowing jobs to recover from a massive hit at the onset of the pandemic.
“If we’re really honest, the main mechanism [to actively fight inflation] relies on the labor market cooling down,” said Skanda Amarnath, executive director of advocacy group Employ America. “That’s something people might find uncomfortable to say.”
For Fed policymakers, it might be worth denting the job market to choke off high inflation, but more immediately, their task is to remove their own support for economic growth by moving rates up from their growth-boosting low levels. If inflation and growth begin to slow markedly this year, as expected by many forecasters, the central bank won’t want to be raising rates too aggressively and overdo it.
“It’s pretty clear we’re headed for more traditional type of growth numbers,” said Omair Sharif, founder of Inflation Insights. “You’re hiking into an inflation slowdown.”
Meanwhile, economists emphasize that the U.S. will need to realize productivity gains to bring worker income up for the long term. Biden’s bipartisan infrastructure bill should help with that as could pandemic-related tech trends, but it’s too early to tell, said Jim Pethokoukis, an 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. That would be a statistic I would look at very closely in the years ahead,” he said.
But more structural changes will be needed as well, argued Erica Groshen, former head of the Labor Department’s Bureau of Labor Statistics. She said less-educated workers often have important skills that are overlooked.
“Over the last 40 years, the real earnings of the median worker in the U.S. have been almost stagnant, even while productivity growth has been rising,” Groshen said. “To reverse that trend is going to take tools that are not in the toolbox of the Federal Reserve.”
Rep. Don Beyer (D-Va.), who chairs Congress’ Joint Economic Committee, similarly said the Fed’s mechanism for fighting inflation was the short-term remedy, while supply chain adjustments and productivity improvements would have more lasting implications.
“I am optimistic that the wage gains will survive the decline in inflation,” he said. “We have plenty of time for the story to change” before the midterm elections.