In A Vital Dashboard Indicator For Monetary Policy: Nominal Wage Targets, a new paper for the Center on Budget and Policy Priorities’ Full Employment Project, EPI Research and Policy Director Josh Bivens argues that the Federal Reserve should provide a target for nominal wage growth that informs its own decisions and larger debates about when and by how much to raise interest rates.

Debate over when the Fed should begin raising interest rates has been intensifying since the beginning of the year, and a key piece of information needed to inform this debate is how much slack remains in the U.S. labor market. Too often, attempts to determine labor market slack focus on quantity measures of slack like the unemployment rate and the labor force participation rate. Instead, Bivens argues, economic observers should be focusing much more attention on the growth rate of nominal wages. By definition, until nominal wage growth accelerates, there is no reason to assume that labor market slack has been substantially eroded.

“While the Fed shouldn’t rely on any single macroeconomic target, given that nominal wage growth has to pick up before we can say definitively that there’s no slack left in the labor market, wage targeting is by far their best option,” said Bivens. “Nominal wage growth needs to get to 3.5 to 4 percent, and stay there, before the Fed thinks about putting on the brakes.”

Bivens provides a direct link between the Fed’s overall price inflation target (commonly assumed to be 2 percent) and the growth rate of nominal wages consistent with this price target. He argues that until nominal wage growth is 3.5 percent, there is no threat that tight labor markets could push overall price inflation above the Fed’s target. Furthermore, an extended period of nominal wage growth above 3.5 percent is needed to return the share of corporate sector income claimed by labor compensation to pre-recession levels. Bivens finds that looking at the labor market through the lens of a nominal wage target shows that the Fed can wait significantly longer before raising interest rates in the name of tamping down price inflation.