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Thursday, May 19, 2011

Fed Fears Wage Increases

I think this is correct in terms of how the Fed is viewing inflation risks:

Fed Fears of Wage Increases Carry Risks, by Kathleen Madigan, RTE: Windfall for commodity producers, no problem. Bigger paychecks for U.S. workers, now wait a minute…
That’s one reading of the minutes from the Federal Reserve‘s April 26-27 Federal Open Market Committee. The strategy makes sense from an economics’ standpoint; but it carries risks on both the political and growth fronts.
According to the minutes, Fed officials continue to think the impact from higher commodity prices will be “transitory.” The bigger concern would be if wage increases took hold. After all, labor remains the biggest expense for most U.S. businesses. If wages were to increase rapidly, companies would be under more pressure to raise their selling prices — which would cause workers to ask for bigger raises to cover the higher prices.
So far, the Fed sees little evidence of that inflationary cycle — mostly because there is so much slack in the labor markets. ... And as long as the pressures on labor costs remain muted, “a large, persistent rise in inflation would be unusual,” the minutes added. In other words, higher prices concentrated in energy and raw materials won’t bring a response from the central bank. But if wages pick up, the Fed may step in.
In theory, the policy is sound, given the dominance of labor costs to pricing decisions. ... But don’t expect the public to welcome the idea that wage gains need to remain “subdued.” The Fed could face more threats of greater oversight from Washington politicians if central bankers are seen as turning a deaf ear to the wants of working voters. Congressional meddling would complicate the Fed’s job.
Second, the price increases being tolerated by the Fed are wreaking havoc on household budgets. ... Without faster real income growth, consumers won’t provide the demand needed to power the recovery. Keeping the recovery going is another ball the Fed needs to keep juggling.

We are much too worried about a wage-price inflation cycle breaking out and causing problems. If the Fed is too trigger happy, it could snuff out the recovery it is hoping to bring about.

The Fed is much, much better at slowing the economy down than it is at speeding it up. Thus, if the Feds is going to make an error, it should be biased toward the error it can fix the easiest. That is, in the face of uncertainty the Fed should be biased toward policy that is too loose rather than policy that is too tight -- a policy that is too loose is easier to correct if it's wrong. Unfortunately, I don't think the Fed sees it this way.

    Posted by on Thursday, May 19, 2011 at 02:07 PM in Economics, Inflation, Monetary Policy | Permalink  Comments (21)

          


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