Our model forecasts no statistically significant additional pressures from wages on prices if year-over-year ECI growth in the fourth quarter lands within the dashed vertical lines, that is, 3.78 to 4.25%. Even for values slightly above this range but in line with recent realizations, our model predicts only a moderate effect of ECI growth on one-year-ahead inflation. Note that our results imply there will be no additional impact on inflation dynamics from the labor market for a range of year-over-year ECI growth for 2023:Q4 that is clearly higher than the sum of the Federal Reserve’s inflation target of 2% and historic average productivity growth. The key economic force behind this result is the catch-up effect referred to above. Because inflation has, on average, grown faster than productivity-adjusted wages in the last three years, there is room for wage growth to surpass inflation for some time so that it aligns with the historic relationships among the growth rates of prices, wages, and productivity.
- Date Posted:
- January 22, 2024
Counterintuitively, elevated wage growth could be a problem for sustaining a strong labor market if it generates concerns about (or actual) higher inflation and leads the Federal Reserve to keep monetary policy tighter than it otherwise would have. Labor productivity growth, however, would alleviate this concern. Figure 4 shows the three measures of wage growth considered above alongside a measure of sustainable wage growth that is equal to productivity growth plus the Federal Reserve’s two percent inflation target. From 2001 through 2019, actual wage growth tracked this measure well, and inflation was low and stable. Since the onset of the pandemic, labor productivity has fluctuated widely (partially reflecting shifts in the composition of employment as acutely exposed sectors reacted and adapted to the pandemic), and beginning in early 2022, actual wage growth substantially exceeded the sustainable benchmark. Over the course of 2023, however, productivity has rebounded while wage growth has moderated, bringing actual wage growth closer to a level that would be sustainable.