I yield to no one in my admiration for the careful, thoughtful, and reality-based economics practiced by Fed Chair Janet Yellen. So I was taken aback a bit by a section in her Jackson Hole speech on Friday.
It was the part where she gave a number of reasons why the absence of wage pressures may not, paradoxically, be signaling that considerable slack remains in the job market, and therefore, may not be signalling that the Fed should wait on raising rates to stave off faster inflation.
I certainly appreciate bending over backwards to look for reasons why the obvious may not be correct—i.e., why the lack of wage growth might not be the sign of job market weakness I think it is. Sure, one should always shave with Occam’s razor, but you can knick yourself if you shave too close.
Still, I don’t think that’s the case at all here. To the contrary, each of her three reasons look like additional reasons not to slow the economy and preempt wage growth by tightening too soon. She’s right to look under new rocks, but as I see it, she found nothing new there.
The three “rocks” are:
nominal wage rigidity: because employers tend not to reduce nominal wages—it’s bad for morale—they don’t need to offer raises now as the job market’s improving. The implication is that diminished slack would not, as expected, be reflected in faster wage growth.
OK, but if this analysis is correct then the key question is “what does the absence of wage pressures–due not to labor market slack but to rigid wages–imply for monetary policy right now?” And the answer is: it implies that until inflation erodes real wages enough to generate more employment demand (i.e., moving down the demand curve), or until there’s enough labor demand to necessitate hiring at current real wage levels (i.e., the demand curve moves out), there’s no reason to tighten.
—structural (i.e., longer-term, non-cyclical) forces that are reducing labor’s share of national income: Yellen cites the role globalization is playing in holding down wage growth for those negatively affected by international trade (I’d add imbalanced trade, as per here). Moreover, she connects this development to the decline in labor compensation as a share of national income and the analytically related point of real compensation growing more slowly than productivity.
But again, go back to the question in italics posed above (is this a reason to tighten sooner than later?). As Dean Baker and I recently wrote, “wage growth paid for by a shift back toward to a more normal split between wages and profits is non-inflationary.” It will take very tight labor markets to rebalance “factor income shares” (the profit and wage shares of national income) and to offset the damage to labor demand and worker bargaining power from imbalanced trade. So here again, pre-emptive tightening is contraindicated.
–depressed labor force participation that could be reversed by stronger demand: Here Chair Yellen pointed out that because millions of workers have left the labor force due to persistently weak demand, “transitory wage and price pressures could emerge well before maximum sustainable employment has been reached, although they would abate over time as the economy moves back toward maximum employment.” That is, depressed labor supply might lead to wage pressures in the near term, but as labor demand strengthened, those sideliners would get pulled back in which would then dampen those pressures, due to the added supply effect.
Even more so than the other two reasons, this one especially calls for extended monetary support of the job market. If we hope to raise the economy’s potential growth rate, it is essential for labor demand to strengthen enough to reverse that portion of the decline in labor force participation that’s reversible—the part due to weak demand (I’d argue that’s about half of the three percentage point decline, over two million workers).
So, not to put too fine a point out it, each of the three reasons Chair Yellen gave as to why the lack of wage pressure may not signal labor market slack actually point in the same direction in terms of monetary policy, as does the conventional wisdom that wage growth is weak because the job market is weak. Good for her for looking under interesting rocks to test the simple story, but what she found there leads to the same policy prescription: hold off on tightening.