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The Fed's Fear of a Wage-Price Spiral Might Soon Abate -- Heard on the Street -- WSJ

The Wall Street Journal · 01/06/2023 11:27

By Justin Lahart

The job market happens to be strong and inflation happens to be high. A big question for the Federal Reserve this year is how much those two things have to do with each other.

At the moment Fed policy makers fear that correlation does, in fact, imply causation. They believe that while some of the rise in inflation can be laid at the feet of temporary factors such as pandemic-related bottlenecks that are now starting to unwind, a tight job market is also to blame.

Friday's employment report from the Labor Department might sow a smidgen of doubt in policy makers' minds, however. True, the economy added a seasonally adjusted 223,000 jobs in December from November, and the unemployment rate slipped to 3.5% from a downwardly revised 3.6%, bringing it back to an over-50-year low.

But average hourly earnings rose by just 0.3% from a month earlier, and November's gain was revised down to 0.4% from 0.6%. That put hourly earnings in December 4.6% above their year-earlier level, versus a 4.8% gain in November. Before Friday's revision, November's wage figure was 5.1% above a year earlier.

Considering that data is subject to revision, the latest wage readings obviously need to be viewed with a bit of skepticism. Still, it is striking that with unemployment so low, and with so many businesses still desperate to hire, wage growth appears to be cooling.

This suggests that the line of causation is less from wages to inflation than vice versa: As inflation heated up, workers asked for higher wages so they could keep up. Now, inflation has begun to cool, so wage increases are cooling, too.

That would be a different situation than in the 1970s, when workers were demanding higher wages because they thought that future inflation was going to remain high. This time around, readings on people's long-run inflation expectations, while higher than just before the pandemic, are still relatively low. Another factor is that the share of workers represented by unions is far smaller, lowering bargaining power.

And finally, people drawing higher wages doesn't necessarily mean that businesses must increase prices in kind. Profit margins are still historically quite high, so it could be that rising labor costs are being absorbed by margin compression rather than higher consumer-price inflation.

Fed policy makers probably aren't going to buy into any of this -- at least not yet. But they might at least become more open to the possibility that the job market isn't as much of an inflationary problem as they feared. This will especially be the case if inflation readings continue to cool.

That increases the likelihood that at their two-day meeting that ends Feb. 1, Fed officials will raise their target range on rates by just a quarter-percentage point rather than half. And after that, it could be time for a pause.

Write to Justin Lahart at Justin.Lahart@wsj.com

(END) Dow Jones Newswires

January 06, 2023 11:27 ET (16:27 GMT)

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