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How Does Fed Think About the Effect of Weaker Labor on Wages?



Should the Federal Reserve continue to raise interest rates even though the US job market remains fairly tepid, inflation is still below its target, and wage growth is nowhere to be seen? These are key questions for monetary policy. Which is why PIIE President Adam Posen took the time to ask Federal Reserve Board Governor Jerome Powell the following during a recent question-and-answer session at PIIE:

Posen: “Clearly, part of what you described when you were talking about monetary policy, and any good central banker would talk about, is how much you worry that if we fall behind the curve will inflation accelerate. Does it ever enter your discussions, or your own personal views more importantly, that labor really is weak now. That for whatever variety of reasons labor just doesn’t have the bargaining power now so the risk of a wage-price spiral is less?”

Powell: “It comes up indirectly. Really if you look at the relationship between slack in the economy and price inflation, and then you look at the relationship between price and wage inflation – both of those relationships have weakened very substantially over the last 20 years.

To say it differently, wage inflation, which has been weak, no longer affects price inflation as much as it used to, and price inflation is no longer as responsive to the economy getting tight. So you can be at full employment and you don’t see much inflation. This is very different from the world we grew up in of wage-price spirals and such. So all of that I think is consistent with a world in which companies maybe substitute capital for labor and labor’s share of income goes down. It’s in the numbers but it’s not something I feel we can target directly with our policies.”

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