Is Even EPI Too Cautious on Wage Growth? Goldman Sachs Seems to Think So

The macroeconomic policy question du  jour is when will the Federal Reserve begin raising short-term interest rates to slow economic recovery and reduce inflationary pressures? We at EPI have been pretty clear on when they should do this: not until wage-growth is much, much stronger.

Since the economic channel through which raising rates stems inflationary pressures is slower job growth, leading to a reduction in workers’ bargaining power and reduced wage growth, this makes data on what is actually happening to wage growth crucially important to Fed decision making.

EPI economists have been tracking this a lot recently and have shown how the Fed’s target for overall price inflation (2 percent) is consistent with wage growth of at least 3.5 percent. We calculate this simply by noting that trend productivity growth is likely at least 1.5 percent and pointing out that it takes wages costs in excess of productivity growth to spur any upward pressure on prices at all. We’ve also noted that the very large decline in the overall share of national income going to labor compensation (see Figure G here) means that the economy could afford an extended period of wage growth outpacing the sum of productivity and price inflation, to allow labor income to claw back some gains it lost to capital owners earlier in the recovery.

Yesterday, the macroeconomic team at Goldman Sachs implicitly argued that this 3.5-4 percent wage growth target is too cautious. In a research note released today (no link available, sorry), they argue that trend productivity growth in the non-farm business sector is 2 percent or higher, not 1.5.

Now, you need to discount a little of this (roughly 0.2 percentage points) to translate productivity in the non-farm business sector to total economy productivity, but the fact remains that even extraordinarily cautious estimates of labor productivity growth (i.e., ours) still means that wage-growth could almost double from today’s levels for an extended period before it puts enough upward pressure on wages to force the Fed to act.