Workers’ wages are rising, complicating the Fed’s inflation battle

Americans continue to win higher wages and better benefits, a welcome development for workers but one that complicates the way forward for the Federal Reserve’s fight against inflation.

Wages and salaries rose 5 percent in March from a year ago, marking an acceleration from the previous year’s increase of 4.7 percent, according to new figures released Friday by the Bureau of Labor Statistics. This salary is in line with inflation, which has also risen by 5 per cent in the past year, and helps to compensate for higher prices for groceries, housing, healthcare and other necessities.

But for decision-makers, the persistently strong wage growth is both a blessing and a curse. On the one hand, they help to maintain consumption and prevent the economy from slipping into recession despite the central bank’s aggressive interest rate hikes. Nevertheless, they also signal that the fight against inflation is far from over.

“Wage growth remains extremely high,” said Gus Faucher, chief economist at PNC Financial Services. “Companies pay the same worker 5 percent more in wages and benefits than a year ago. That is much, much higher than the 2.5 to 3 percent increase we saw before the pandemic, and contributes to high inflation throughout the economy.”

Strong economic decline triggers new recession fears

The Fed has taken aggressive steps to slow the economy in hopes of putting a lid on rapidly rising prices. It has raised interest rates by around 5 per cent in the past year, and is expected to do so again by a quarter of a percentage point next week.

The higher borrowing costs are already working across the economy, slowing housing, manufacturing and other industries most sensitive to interest rate changes. But even though the labor market has slowed, it has remained incredibly resilient. Employers continue to hire hundreds of thousands of workers a month, and the unemployment rate, at 3.5 percent, is near a 50-year low.

The tight environment, where vacancies continue to outnumber available workers, has helped lift wages and benefits across industries. Total compensation for office workers, hotel and restaurant workers and construction workers, for example, all rose 1.5 percent in the latest quarter, outpacing overall growth of 1.2 percent, according to Friday’s employment cost index report. The data also show that wage growth picked up in the first three months of 2023, after slowing for three consecutive quarters.

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The recent increase in wages, which began in late 2020, comes after years of stagnation following the Great Recession. For years wage growth remained steady as employers had the upper hand. But that changed quickly during the pandemic, when widespread labor shortages forced employers to raise wages and other benefits to attract and retain workers. Total compensation rose by 3.3 per cent in 2021, and 4.9 per cent last year.

These gains have been particularly pronounced in low-paid sectors such as leisure, hospitality and other service industries which are still struggling to find enough labour.

“Obviously from a worker’s perspective, making more money in the paycheck is always going to be a good thing,” said Cory Stahle, an economist at jobs site Indeed. “But the Fed wants more balance: It wants people to still have money in their pockets, but not so much that they go out and spend more, driving up inflation.”

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