The recent surge in pay levels should be good news for workers and the economy. However, it is becoming increasingly apparent that there can be too much of a good thing. Higher wages are not only fueling inflation but also creating a challenge for the Federal Reserve in their efforts to regain control over prices. Consequently, the Fed is likely to continue raising interest rates in order to slow down the economy, ultimately increasing the risk of a recession.
The dilemma faced by the Fed becomes evident when we analyze the June U.S. employment report. According to the government, hourly wages have increased by 0.4% for the third consecutive month, resulting in a year-on-year increase of 4.4% – nearly twice the norm seen before the pandemic. Furthermore, wage growth seems to have hit a standstill, remaining between 4% and 5% after experiencing a significant slowdown last year.
One of the key factors contributing to this ongoing wage growth is U.S. inflation, which has also become stagnant within the 4% to 5% range. Unsurprisingly, a substantial portion of this inflation can be attributed to increased labor costs, as labor stands as the largest expense for most businesses.
Stuart Hoffman, senior economic adviser at PNC Financial Services, asserts that wage gains continue to be excessively strong. Although this sentiment may not be what workers want to hear, it is a reflection of the current economic situation. While bigger paychecks have provided some relief in light of rising prices, it is essential to strike a balance.
Ideally, the Fed would like to see the economy slow down sufficiently to reduce the demand for labor. This, in turn, would alleviate the upward pressure on wages and bring the inflation rate back down to the central bank’s target of 2%. However, economists recognize that the Fed is still far from achieving this goal, and the only way to move closer may be by implementing further interest rate hikes.
According to Hoffman, wage growth below 4% seems unlikely until there is a significant weakening in the job market. However, creating such market conditions without triggering a mild recession poses an additional challenge for the Fed.
In conclusion, the current rise in wages has proven to be a double-edged sword. While it benefits workers, it also contributes to inflation and creates difficulties for the Federal Reserve. Striking a delicate balance will be crucial as the central bank navigates the path towards stabilizing prices and avoiding potential economic downturns.
