Strong wage growth is normally a good thing for workers and a boon to the economy.
Utilities? Not so much.
Average wage increases are approaching their highest level in decades, fueling inflation, the Federal Reserve says. And that could force Fed officials to hike rates even further next year, threatening to push the US into a mild recession.
Economists say moderating wage growth is key to avoiding a recession.
But maybe it’s not that simple.
What is the average wage increase in 2022?
Average annual wage increases fell from 5.7% at the start of the year to 5.2% in the third quarter, according to the Labor Department’s Employment Cost Index. But that’s still well above the average of 3.3% before the pandemic and about 2% in the decade before the health crisis.
Robust pay increases are usually a good thing. However, since the COVID crisis, they have not kept pace with inflation, meaning consumers are losing purchasing power.
But the spike in wage growth contributes to inflation, as employers with high labor costs typically raise prices to keep up profits.
Reminder Warning:Target recalls 204,000 weighted blankets after two children reportedly die from suffocation
Discount on used car prices?:Used car prices are expected to fall by up to 20% in 2023 as inventory stabilizes
Meanwhile, the Federal Reserve has hiked interest rates sharply to lower annual inflation, which reached 9.1% in June and fell to a still high 7.1% in December.
The Fed has raised its policy rate by more than 4 percentage points in 2022, the highest level since the early 1980s, and forecasts another three-quarters of a point increase to about 5.1% next year. That’s a level that many economists say will send the nation into recession.
Fed Chairman Jerome Powell has said the Fed will continue to raise rates until wage growth is under control.
Why are wages rising so fast?
Inflation, especially in service industries such as restaurants and healthcare, has remained high as consumers shift purchases to activities such as dining out and travel as the pandemic has eased. That has fueled demand for workers in those sectors and pushed up wages. Powell said price increases in those sectors make up more than half of a key underlying inflation measure and are mostly driven by wage increases.
Labor shortages in those industries continue as millions of Americans quit during the health crisis due to COVID or early retirement. Many are not expected to return. So employers must raise wages to tap into a smaller pool of applicants or lure back those who have left.
“Wages are running…well above what would be consistent with 2% inflation (the Fed’s target),” Powell said at a news conference this month. “We have a way to get there.”
He added: “The labor market remains unbalanced, with demand significantly outpacing the supply of available labor.”
Another inflation measure is easing:PCE inflation slowed to 5.5% in November. Core inflation also fell
Take a look inside basketball mogul:How Mat Ishbia Parlayed Passion For Basketball, Mortgage Fortune To Buy Major Stake In Phoenix Suns, Mercury
What actually happens when the Fed raises interest rates?
Traditionally, the Fed raises interest rates to raise borrowing costs, weaken the economy, and make it more expensive for companies to hire and invest. Increases in the unemployment rate generally lead to lower wage increases, and vice versa.
But that relationship between unemployment and wage growth — known as the Philips curve — has frayed in recent decades, says Jonathan Millar, a senior economist at Barclays in the US.
In the decade following the Great Recession, unemployment fell sharply, while wages rose modestly. That’s largely because Americans came to expect weak inflation for a variety of reasons and didn’t demand big increases.
As a result, Millar says, roughly every percentage point increase in the unemployment rate causes only a quarter point drop in wage growth. So, he says, it may take as much as an 8 percentage point rise in unemployment to shave wage increases by 2 percentage points to 3% to 3.5%. Such a scenario would mean a serious recession.
Lots of Yeezys:Adidas rushes to sell $530 million worth of Yeezys after cutting ties with Ye, report says
Another factor that could keep wage growth high, according to Millar, is that the number of job openings fell from a record high of 11.5 million a year ago to 10.3 million in October, but that is still well above pre-COVID level of 7 million.
While job growth is expected to slow as the economy loses momentum next year, employers may still need to offer healthy pay raises to attract workers because there are fewer of them, Millar says.
Is US inflation going down?
Mark Zandi, Moody’s Analytics chief economist, is more optimistic. He does not believe wage growth during the pandemic was driven higher by labor shortages, but rather by high inflation expectations.
Record gasoline prices, supply chain problems and Russia’s war in Ukraine drove consumer prices higher, prompting workers to demand higher wage increases.
Now, however, pump prices have fallen sharply and supply issues have improved, lowering consumer inflation expectations for the next 12 months. according to recent studies.
“That should reduce wage growth,” Zandi said.
He expects annual wage increases to fall to 4% by the end of 2023 and 3.5% by mid-2024, persuading the Fed to scale back its rate hikes as the trend becomes apparent early next year.
And that, he says, should help the economy avoid recession.