Jerome Powell, chairman of the U.S. Federal Reserve, adjusts his tie while attending a Group of 20 (G-20) finance ministers and central bank governors group photo on the sidelines of the spring meetings of the International Monetary Fund (IMF) and World Bank in Washington, D.C., U.S. (Photographer: Andrew Harrer/Bloomberg)  

U.S. Faces Tough Scenario If Inflation Takes Off and Pay Doesn't

(Bloomberg) -- Prices and wages have been slow to accelerate throughout the U.S. economic expansion, surprising economists. Now, a new conundrum threatens to emerge: Faster inflation accompanied by more of the same paltry growth in pay.

“Broad-based wage gains, in our business at least, they’re just not going to happen,” Troy Taylor, chief executive officer at Coca-Cola Beverages Florida, said during a conference at the Federal Reserve Bank of Dallas last week. The company will pay for some skilled workers, but will otherwise increasingly turn to technology to fill its production needs, he said.

“As businesses do get more pricing power, because we will, what happens to that segment of the population that cannot get a wage gain?" he asked.

It’s a key question for U.S. central bankers, and is one reason to keep the pace of rate hikes slow and steady even as inflation converges to Fed policy makers’ 2 percent goal. Unemployment is at a 17-year low, but if something has changed that structurally prevents low joblessness from yielding higher pay -- be it new technologies, stubborn slack in the labor market, or a coming rebound in capital spending -- the contours of the economy could be totally different.

Two-Speed Economy

Without sustained pay increases, it could be tough to fuel the strong spending needed to sustain demand-based price gains. Or, if higher pay accrues only to skilled, in-demand workers, the Fed could have a dramatically two-speed economy on its hands -- one in which affluent employees enjoy fatter paychecks and spur growth even as workers with less skill and experience increasingly lag behind.

Wages have been rising, but progress has been slower than Fed officials expected. The employment cost index, a measure of both pay and benefits, increased 2.7 percent in the year through the first quarter, the largest advance since 2008 but well below the above-3 percent readings that were common prior to the last crisis. Annual gains in average hourly earnings, another closely-watched measure, have been oscillating around 2.5 percent -- up since the crisis, but down compared to historical norms.

Rate Hikes

The Dallas Fed’s own manufacturing survey, released Tuesday, showed that as prices received move higher -- the index is hovering around the highest level in nearly seven years -- the measure gauging the outlook for wages and salaries actually dipped in May and has yet to break out in a sustained way.

Lagging wage growth has attracted the central bank’s attention.

“I’ve been saying, ‘Hey, let’s not overdo it,’” Minneapolis Fed President Neel Kashkari said on May 21, explaining that the Fed can always pick up the pace of rate hikes if wage growth kicks in.

U.S. Faces Tough Scenario If Inflation Takes Off and Pay Doesn't

Lackluster wage growth has been tolerable because inflation has been low and steady, keeping purchasing power intact. Economists usually think that wages and inflation move together, so higher prices without more pay is theoretically unlikely. But if they decouple due to a supply shock or some structural change in the economy, the stakes would be high.

“That’s going to be a real tough one -- because you’re going to have a sizable segment of the population, no wage gains, you’re going to see prices start to go up, and what does that do to actual individual buying power?” Coca-Cola’s Taylor said during the conference.

Michael Feroli, chief U.S. economist of JPMorgan Chase & Co. in New York, expects both earnings and prices to move up gradually. But if inflation took off without paychecks leading or following suit, he said “it would complicate the situation.”

“It would make it less popular to be tightening policy, but if we revert to the experience of the 2000s, when the labor share was shrinking, the Fed was hiking,” Feroli said. “At the end of the day the scoreboard is really with prices.”

©2018 Bloomberg L.P.