Among some at Fed, argument grows for patience on wage costs

By Howard Schneider

WASHINGTON (Reuters) – As the U.S. economy reopened from the pandemic in 2021 and companies cottoned on to the pricing power at hand from supply shortages and consumers’ eagerness to spend, corporate profits spiked, claiming the highest share of national income in 60 years.

Profits would claim more than 15.5 cents on the dollar that year and the next, a full 2 cents higher than the average of 13.5 cents from 2010 to 2019. That surge is now driving debate inside the U.S. Federal Reserve about how much weight to give ongoing wage increases as policymakers assess the path of inflation.

Staff at the Atlanta Fed, noting that over the last two years the larger share of profits came at the expense of labor’s portion, argue wages could continue rising without prompting higher prices since the profit side has room to give back as the economy returns to a more normal footing.

Graphic: Profit share over time – https://www.reuters.com/graphics/USA-ECONOMY/UNEMPLOYMENT/xmpjkemkbvr/chart.png

Chicago Fed research has argued wages say more about what happened with prices in the past than they do about what will happen in the future, while St. Louis Fed economists have said that, regardless of the pace of wage growth now, once excess savings for the pandemic years are spent both the rates of inflation and wage growth should decline.

“You have to go back several decades to see a time when the profit share of price has been as high as it is now,” John Robertson, an economist and senior policy advisor at the Atlanta Fed, told Reuters earlier this month. “If profit margins were to come back down to the normal, pre-COVID level, that would give some room for labor’s share to increase and still have everything work out” for inflation to return to target.

Fed officials will receive an update Friday on the Employment Cost Index, a statistic that, because it is released only quarterly and includes wages and benefits, provides the best view of how the low unemployment rate and still-difficult hiring environment influences the cost of producing goods and services.

Graphic: Labor share over time – https://www.reuters.com/graphics/USA-ECONOMY/UNEMPLOYMENT/lbpggzaorpq/chart.png

The Fed will also receive updated data on the personal consumption expenditures price index, the measure it uses to set its 2% price target.

Economists expect mixed results. In a recent Reuters poll economists said they anticipate the price index, excluding food and energy, will have dropped slightly in March, from a 4.6% annual rate to 4.5% – tepid progress though continuing a downward trend.

The employment cost data, however, is expected to show an increase of 1.1% over the first three months of the year, faster than the 1% increase in the prior quarter and equivalent to about a 4.47% annual rate. It had never been above 3% in the decade prior to the pandemic.

The Fed is widely expected to raise interest rates another quarter of a percentage point when policymakers meet next week, lifting the benchmark federal funds rate to a range between 5% and 5.25%.

Graphic: Profits surged in the pandemic – https://www.reuters.com/graphics/USA-FED/WAGES/lbvggzargvq/chart.png

But policymakers will also have to indicate if they are ready to pause further rate increases after next week or not, a decision that hinges on whether they think inflation is now on a durable downward path.

To some, the current low unemployment rate of 3.5%, coupled with the fact that inflation has become more concentrated in labor-intensive service industries, is reason for concern.

Fed Chair Jerome Powell has focused in particular on the persistence of inflation in the service sector outside of housing, and after the March meeting of the Federal Open Market Committee said progress there “will have to come through softening demand and perhaps some softening in labor market conditions. We don’t see that yet.”

How to connect labor market metrics to inflation, however, remains a live topic, and in particular there has been recent pushback against the idea that wages tell the full story.

The share of each dollar of output going to workers at nonfinancial corporations averaged 58.3% in 2022. While that was above the level typically seen prior to the pandemic, the labor share had been rising steadily from 2013 on and hit 59.3% in 2019. Until a wave of globalization in the early 2000s it was well above 60%.

Graphic: Employment Cost Index – https://www.reuters.com/graphics/USA-FED/WAGES/dwpkdlwrevm/chart.png

“The one thing that I think we’re spending too much time looking at is wage growth as an indicator of prices,” Chicago Fed President Austan Goolsbee told CNBC this month, citing recent research by Chicago Fed staff. “They’re a lagging indicator…When people are looking at what’s happening to wages now, that’s more reflective of what happened to prices six months ago.”

St. Louis Fed Assistant Vice President Michael McCracken said he views much of what is happening with wages and prices today as the result of extra savings – still estimated by some economists to be in the hundreds of billions of dollars – that households accumulated during the pandemic months and are still spending.

He said he views rising wages as the result of that still- strong demand, something that should ease alongside price pressures once the money is gone.It was an argument heard more frequently in the early days of the pandemic, but McCracken said when he sees the crowds on airplanes or the perpetually packed parking lot at his favorite restaurant “it just makes way too much sense.”

“We burn through those excess savings…and then we’re all good,” McCracken said, an outcome he feels could be obtained without a major raise in unemployment.

(Reporting by Howard Schneider; Editing by Dan Burns and Andrea Ricci)

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