Janet Yellen: Three Reasons Wage Trends Can’t Be Trusted

Janet Yellen is speaking now from the Kansas City Fed’s junket in Jackson Hole. The Federal Reserve has released the full text of her address and on the surface, it appears dovish enough (which was the expectation).

I thought this bit on recent trends in wages was interesting – hard to have inflation in the absence of wage growth, also hard to have a recovery that people believe in.

…since wage movements have historically been sensitive to tightness in the labor market, the recent behavior of both nominal and real wages point to weaker labor market conditions than would be indicated by the current unemployment rate.

There are three reasons, however, why we should be cautious in drawing such a conclusion. First, the sluggish pace of nominal and real wage growth in recent years may reflect the phenomenon of “pent-up wage deflation.” The evidence suggests that many firms faced significant constraints in lowering compensation during the recession and the earlier part of the recovery because of “downward nominal wage rigidity”–namely, an inability or unwillingness on the part of firms to cut nominal wages. To the extent that firms faced limits in reducing real and nominal wages when the labor market was exceptionally weak, they may find that now they do not need to raise wages to attract qualified workers. As a result, wages might rise relatively slowly as the labor market strengthens. If pent-up wage deflation is holding down wage growth, the current very moderate wage growth could be a misleading signal of the degree of remaining slack. Further, wages could begin to rise at a noticeably more rapid pace once pent-up wage deflation has been absorbed.

Second, wage developments reflect not only cyclical but also secular trends that have likely affected the evolution of labor’s share of income in recent years. As I noted, real wages have been rising less rapidly than productivity, implying that real unit labor costs have been declining, a pattern suggesting that there is scope for nominal wages to accelerate from their recent pace without creating meaningful inflationary pressure. However, research suggests that the decline in real unit labor costs may partly reflect secular factors that predate the recession, including changing patterns of production and international trade, as well as measurement issues. If so, productivity growth could continue to outpace real wage gains even when the economy is again operating at its potential.

A third issue that complicates the interpretation of wage trends is the possibility that, because of the dislocations of the Great Recession, transitory wage and price pressures could emerge well before maximum sustainable employment has been reached, although they would abate over time as the economy moves back toward maximum employment. The argument is that workers who have suffered long-term unemployment–along with, perhaps, those who have dropped out of the labor force but would return to work in a stronger economy–face significant impediments to reemployment. In this case, further improvement in the labor market could entail stronger wage pressures for a time before maximum employment has been attained.

Source:

Labor Market Dynamics and Monetary Policy (Federal Reserve)