July 24, 2023
In the last sixteen months, we have seen the fastest run-up in interest rates since Paul Volcker declared war on the 1970s inflation spiral. The Fed’s rate hikes to date have had less impact in slowing the economy and job growth than almost anyone anticipated, including the Fed itself. Nonetheless, inflation has slowed sharply by every measure, as has wage growth. We are now approaching rates of wage and price growth that are close to the Fed’s target. Given this situation, it is important that the Fed step back from its path of rate hikes to get a clearer sense of where the economy is going.
On the wage side, our best data set is the Average Hourly Earnings (AHE) series. This shows the annualized rate of wage growth over the last three months at 4.4 percent. This is down from 6.6 percent at the start of 2022. There were periods in 2018 and 2019, when the inflation rate was at the Fed’s target, when the annualized rate of wage growth hit 4.0 percent, so we are not far from seeing a pace of wage growth consistent with the Fed’s inflation target.
Other wage measures also show slowing, even if the drop is not quite as dramatic as in the case of AHE. In the case of the hourly compensation series in the productivity data, the falloff has been even sharper, with year-over-year compensation growth falling from 6.4 percent in the first quarter of 2021, to 5.4 percent in the first quarter of 2022, and just 3.0 percent in the most recent quarter.
An independent, but underappreciated, source of wage data is the Indeed series on wages of new hires. The year-over-year growth of wages in this series peaked at 9.3 percent in January of 2022. The rate had fallen to 5.3 percent by May. Their current projection is that we will return to the pre-recession rate of wage growth of 3.1 percent by the end of this year or the start of 2024.
The price indices also show a similar pattern of slowing. The annualized rate of inflation over the prior three months in the overall CPI has slowed from almost 10 percent at the end of 2021 to 3.0 percent in the most recent period. Inflation in the core index slowed from almost 8.0 percent to just over 4.0 percent.
We know for certain that there will be further declines in inflation in the coming months. As has been widely noted, indexes measuring the rent of marketed units, including the BLS measure, show sharply lower rental inflation. Used and new car prices are reversing their sharp price increases in the pandemic, now that production and inventory levels are returning to normal. And, non-fuel import prices have been falling over the last year, after rising sharply in 2021 and 2022.
The full impact of the Fed’s past rate hikes has not yet been felt. We know that they have created serious stress for at least some segments of the financial system. Given recent trends in wages and prices, it would be a good time for the Fed to step back from its path of rate hikes to get a better sense of where the economy is going and the impact of its past hikes. The issue here is not just a one-time pause, but rather a clear statement from the Fed about its future path.
Financial markets have already priced in a July rate hike. If the goal is to bring near-term stability to financial markets, the Fed needs to make a clear statement that it is stepping back from its path of rate hikes and that future moves can be in either direction with equal probability.
Fed policy has largely accomplished its goal with its policy moves to date. It should not risk the health of the recovery by continuing to push for higher rates or by leading financial markets to believe it will continue to push for higher rates.
