The Stakes are High at the Fed
On Friday, EPI’s Larry Mishel and I joined a group of workers and community activists who are urging the Federal Reserve to resist pressures to raise interest rates before the labor market has fully recovered and who are also calling for greater public input into the selection of regional Fed bank presidents and board members.
At a press briefing outside the Fed before the meeting, organized by the Center for Popular Democracy, featuring workers and community organizers, I delivered the following remarks:
Hello, I’m Josh Bivens, the Director of Research and Policy at the Economic Policy Institute here in Washington, DC and a macroeconomist. I’m going to try to provide some economic context for today’s meeting and highlight the high stakes in this debate.
But I’ll start just by saying that I think today’s meeting with Federal Reserve Chair Yellen and this group is a hugely encouraging event.
Encouraging because the Federal Reserve is the most influential policymaking institution in the United States—and likely the world—yet far too few American realize the enormous stake they have in decisions made there.
The single most important determinant of whether or not workers’ wages will begin outpacing inflation in coming years will be when the Federal Reserve decides to begin raising short-term interest rates. If they do this too soon then wages will not outpace inflation. If they instead continue targeting a full recovery from the Great Recession, then there’s a solid chance that these wages will rise faster than prices and provide rising living standards.
There is a flawed conventional wisdom that says the Fed must be insulated from political pressures because it has to be free to make data-driven decisions. But all that participants in today’s meeting are asking is precisely that data—not economic theory or dogma or speculative concerns about inflationary pressures appearing sometime in the future—drive the decisions of the Fed’s open market committee.
This data argues clearly that the U.S. economy remains far from fully recovered from the damage inflicted by the Great Recession and its aftermath. The headline unemployment rate remains too high relative to what it should be in a healthy labor market, and yet it still almost surely tells too rosy a story about the state of recovery.
Other data points indicate a much larger gap between today and a healthy labor market. The share of prime-age adults—those between 24 and 54 years old—with a job has recovered less than half the decline it experienced after the Great Recession.
To be clear, the labor market is improving—but the pace of improvement is too slow.
Most telling of all is the indicator that has not improved at all in recent years: nominal hourly wage growth has hovered at somewhere between 2 and 2.5 percent since the recovery’s beginning. Given that the Fed’s mandate is to essentially balance the benefits of increased economic activity and job-growth against the risk of unleashing inflationary pressures, measures of wage-inflation would seem to be a natural bottom-line indicator of when the Fed should begin tightening to rein in job-growth.
The Fed’s overall price inflation target is 2 percent. Trend productivity growth is somewhere between 1.5 and 2 percent. And wage-growth equal to productivity growth provides no upward pressure on inflation at all—yes each hour of work costs 2 percent more, but each hour of work produces 2 percent more output, so labor cost per unit of output if flat. Accounting for this trend productivity growth means that nominal wages should be rising at a 3.5-4 percent annual rate to be consistent with the Fed’s 2 percent inflation target.
Add on top of this the fact that the share of domestic income accounted for by labor compensation fell like a stone in the early recovery from the Great Recession and has yet to mount a comeback, and this means we could see wage growth that was easily twice as fast as what we’ve been seeing since the recovery began before the Fed should think at all that it’s time to pullback on support to the recovery.
Finally, it seems appropriate to note that the stakes are highest in this debate for communities facing particular labor market disadvantage because of legacies of discrimination. In our materials that we’ve handed out we have calculated unemployment rates by race in the cities with Federal Reserve banks.
The most obvious thing that stands out in these data is the simple fact that across the nation, the Black unemployment rate is reliably just less than twice as high as the overall unemployment rate (and about exactly twice as high as the White unemployment rate), in good times and bad. This means that when White unemployment rises by a percentage point in a recession, the Black unemployment rate rises 2 percent. More hopefully, when White unemployment falls a percentage point due to economic recovery, the Black unemployment rate falls 2 percentage points. And if the Fed were to prematurely tighten interest rates and stop providing a boost to recovery when the overall unemployment rate still had an excess 1 or 2 percentage points that it could fall before sparking an uptick in inflation, this means excess Black unemployment would be 2 to 4 percentage points.
In short, the stakes are high—and they’re the highest for those struggling the most in the still-damaged American labor market. Given this, the meeting today couldn’t be more important.