Will Friday’s Fed wage growth prevent a defeat from the jaws of victory?

This Friday’s data from the Bureau of Labor Statistics (BLS) could have a huge impact on what the Federal Reserve does over the next few months. If, as we think, Friday data Continue to show a slowdown in wage growth, the Fed really doesn’t need to raise interest rates anymore to curb inflation. But if the Fed ignores it and tightens somehow, the glorious achievement of a quick recovery from the worst economic shock of the century could be set back, snatching defeat from the jaws of victory.

In March and April 2020, when COVID-19 first spread across the United States, 22 million jobs were lost. Thanks to the CARES Act, passed in April 2020, the first 12 million jobs returned quite easily over the next six months – businesses that closed but didn’t go bankrupt in months of lockdown simply reopened. But between August 2020 and December 2020, job growth slowed each month, and in this last month, employment Contract. Progress has not just stopped, but reversed. At a similar stage in the recovery from the Great Recession of 2008–2009. turned to austerity and as a result it turned out like this whole 10 years restore the pre-crisis state of the labor market.

This time, however, additional fiscal support was passed in December 2020 and the US bailout plan in March 2021. And since December 2020, the pace of job growth has been impressive, with 9.2 million jobs added in 17 months – about 540,000 jobs each year. single month. This was facilitated by fiscal policy, but the Federal Reserve also played an important supporting role in accelerating growth during this time. Today, unemployment has fully recovered to pre-pandemic levels, and labor force participation has almost recovered. it huge political achievement.

But this job boom was accompanied by too high inflation. The most pressing current question is, should the Fed continue with the much higher pace of interest rate hikes they started with the June FOMC meetings? At that meeting, they raised rates by 0.75% and signaled not only that bigger hikes were coming, but that not even the threat of overshoot and recession could dissuade them. This sharp hawkish reversal did not happen out of nowhere – Fed extreme pressure from many voices “get out of the way of the inflation curve” and raise rates quickly. These votes were, in effect, trying to give the Fed permission to force a recession that is often described as “necessary” to curb inflation.

What does all this have to do with this week’s jobs report? All. No matter where you stand at sources last year’s inflation, everyone agrees that this pace wage growth this will determine how hard the Fed will have to put on the brakes on the economy to bring inflation down over the next 6-12 months. The whole point of raising rates is to slow down overall economic spending and provoke an increase in unemployment so that labor income growth can be curbed, which will dampen both potential drivers of inflation (wages) and household demand for goods and services.

What exactly wage growth rate is this consistent with the Fed’s long-term inflation target and signal that the Fed may stay on the sidelines of raising rates? About 3.5–4.5%. Productivity growth (how much additional output is produced per hour worked in the economy on average) allows wages to rise by about 1.5% per year without putting any upward pressure on prices. But the Fed’s goal is not zero inflation, but 2%. Add that 2% tolerable inflation to 1.5% productivity growth and you have wages that can rise by 3.5% without increasing inflation or cutting profits (all wage growth can be financed by 2% price increases plus productivity growth of 1.5%. Add to that the fact that profits are now historically high and likely to must cut back several years with faster wage growth and you can easily see wage growth by 4.5% in line with the Fed’s overall inflation target and the gradual normalization of the income distribution between wages and profits.

So, on Friday, look at how much wage growth exceeds that 4.5% to see if we need the Fed to keep raising rates. The most popular way to report this wage increase is by comparing wages in June 2022 to their level in June 2021. But this is too retrospective for a debate about the coming year. For example, if wages rose rapidly from June 2021 to December 2021 but have slowed significantly since then, then recent months are more important for the Fed’s decision making.

In the past few months, it has become clear that wage growth does seems to slow down a lot for later periods. Between May 2021 and May 2022, wages increased by 5.5%. But compare wages in March-May 2022 to the previous three months, and that growth (expressed on an annualized basis for apples to apples) is only 4.3%. And over the past two months, annual growth was only 3.8%.

We’ll be keeping a close eye on that payroll data on Friday. If this is like the numbers above, the implications are striking: there really is no need for further tightening by the Fed. And if they go too far, too fast, the brilliant achievement of a quick recovery from the terrible economic shock could be missed.