What to watch on Jobs Day: The call for a rate increase is not backed up by wage data
On Friday, the Bureau of Labor Statistics will release the November numbers on the state of the labor market. On December 15, the Federal Open Market Committee will meet to determine whether they should raise interest rates, and most prognosticators think that this time they will actually go through with it. Last month’s stronger than expected jobs report led many to declare, prematurely, that it is time to start raising rates in order to ward off incipient inflation. The reality is that we need to see strong wage growth that is consistent and strong enough so that labor share of income returns to pre-recession levels and the labor market achieves a full recovery. Then, and only then, should we begin a conversation about raising rates.
Over the last six years, nominal wage growth has continued hover around 2.0 to 2.2 percent, far below target (see below on the target). Yes, October’s year-over-year growth was stronger—2.5 percent for nonfarm employees, although it was lower for production and nonsupervisory workers (2.2 percent). But again, one month of data is not sufficient evidence, and even 2.5 percent is still far below the wage target.
Nominal wage growth has been far below target in the recovery: Year-over-year change in private-sector nominal average hourly earnings, 2007-2016
|All nonfarm employees||Production/nonsupervisory workers|
*Nominal wage growth consistent with the Federal Reserve Board's 2 percent inflation target, 1.5 percent productivity growth, and a stable labor share of income.
Source: EPI analysis of Bureau of Labor Statistics Current Employment Statistics public data series
Another word about the wage target (the shaded region on the graph above). The nominal wage target of 3.5 to 4 percent is defined as nominal wage growth consistent with the Federal Reserve’s 2 percent overall price inflation target, 1.5 to 2 percent productivity growth, and a stable labor share of income. As an example, if trend productivity growth is 1.5 percent, this implies that nominal wage growth of 1.5 percent puts zero upward pressure on overall prices; while an hour of work has gotten 1.5 percent more expensive, the same hour produces 1.5 percent more output, so costs per unit of output are flat. Nominal wage growth of 3.5 percent with 1.5 percent trend productivity growth implies that labor costs would be rising 2 percent annually—and if labor costs were stable as a share of overall output, this implies prices overall would be rising at 2 percent, which is the Fed’s price growth target.
So, what do I mean by stable labor share of income? Below I chart the share of corporate-sector income received by workers over the last three-and-a-half decades (most recent data available is July 2015). Typically, labor share rises during recessions because profits fall much faster than wages during downturns. Then, in the early stages of recovery, labor share falls significantly as profits increase much more rapidly than wages. Usually, labor share then rises again late in the expansion as labor markets tighten and workers regain the bargaining power necessary to secure wage increases. So far, it does appear that labor share has turned the corner, but has still not begun any significant or reliable rise following its long fall in the recovery from the Great Recession. The share of income going to workers is still far below where it was prior to the start of the recession and below even where it was at its lowest point in the 1980s and 1990s business cycles.
Workers’ share of corporate income hasn’t recovered: Share of corporate-sector income received by workers over recent business cycles, 1979–2016
Note: Shaded areas denote recessions. Federal Reserve banks' corporate profits were netted out in the calculation of labor share.
Source: EPI analysis of Bureau of Economic Analysis National Income and Product Accounts (Tables 1.14 and 6.16D)
A tighter labor market should eventually lead to stronger wage growth and a return to pre-recession labor share of income. It’s clear that we are not there yet. And, the jobs report on Friday will likely reinforce that fact. For that reason, the Federal Reserve has been doing the right thing, and should continue to resist raising interest rates.