A Small Step in the Wrong Direction

December 17, 2015

Dean Baker
U.S. News & World Report, December 17, 2015

View article at original source.

The Fed’s decision to raise interest rates on Wednesday was a small step in the wrong direction for the nation’s monetary policy. The point of this rate hike was to slow the economy out of the fear that it is creating too many jobs and that we could see too much upward pressure on wages. The Fed is concerned that more rapid wage growth would soon turn into higher inflation, which could then pose a problem if it spiraled upward. It is difficult to see the basis for this concern.

At 5 percent, the unemployment rate is reasonably low, but most other measures of the labor market are near recession levels. The number of people involuntarily working part time soared during the recession. It has since fallen, but it is still near the highs reached following the 2001 recession.

The story with measures of unemployment duration is the same. There are fewer long-term unemployed than in 2009 and 2010, but the length of unemployment spells is still close to what we see in a normal recession. Another standard measure of labor market strength is the percentage of workers who feel confident enough to quit their jobs without another job lined up. This measure also remains near the low points reached in 2002.

One of the reasons unemployment has fallen so much in the recovery is that millions of people have dropped out of the labor force. If we look at employment rates rather than unemployment, the percentage of prime age workers (ages 25-54) with jobs is still down by almost three full percentage points from the pre-recession peak and by more than four full percentage points from the peak hit in 2000. This is not a picture of a strong labor market.

Moving directly to wages, there has been a very modest uptick in wage growth recently, but wages still only grew by 2.7 percent over the last year. By comparison, wages were growing at close to a 3.5 percent annual rate before the downturn.

If wage growth increased to this pace, it would still be consistent with the Fed’s 2 percent inflation target. And, it is important to remember that 2 percent inflation is supposed to be an average, not a ceiling. Since the inflation rate has been well below 2 percent over the last six years, it can be above 2 percent for a considerable period of time and still be meeting the Fed’s target.

This is an important point. Over the four decades prior to the crash, there was little change in the distribution of income between wages and profits. The high unemployment during the downturn led to a sharp redistribution from wages to profits. As a result, wages are more than 6 percent lower in 2015 than would be the case if the wage share was at its pre-recession level.

It is reasonable to believe that if the Fed allowed the labor market to continue to tighten, workers would regain the share of income lost in the downturn. But this means allowing unemployment to continue to fall and allowing wage growth to pick up steam. It may also mean some increase in the rate of inflation.

Wednesday’s rate hike won’t by itself prevent further labor market tightening, but if the Fed moves ahead rapidly with further hikes, it will be locking in this redistribution to corporate profits for some time to come. That would be very bad news for the nation’s workers. The Fed indicated it would be cautious with any future hikes. Hopefully it will stick to this commitment.

Support Cepr


If you value CEPR's work, support us by making a financial contribution.

Si valora el trabajo de CEPR, apóyenos haciendo una contribución financiera.

Donate Apóyanos

Keep up with our latest news