The economy is hot, not overheated

ANOTHER first Friday of the month, another strong jobs report. Except there’s nothing ho-hum about it. In year nine of this expansion (since 1945, the average expansion has lasted about five years), the U.S. job market is still going strong, creating around 190,000 jobs per month. That’s the average monthly gain over the past year; last month, payrolls were up by 201,000. The unemployment rate, at 3.9 percent, is the lowest it has been in a couple of decades, and I’d guess it’s heading lower.

Granted, wage growth has lagged the rest of the good news. But wages got a nice pop last month, up 2.9 percent, their fastest growth rate since 2009. As a responsible statistician, I must down-weight any one-month result, but my analysis of Bureau of Labor Statistics data takes a six-month average of recent wage gains by middle-wage workers and shows what could be, if it sticks, an uptick in the trend.

To be clear, these are nominal wage gains, before inflation. And consumer inflation has been relatively high in recent months, mostly due to energy costs. (You’ll see in a moment why that distinction is very important.) But I expect slower price growth in coming months, and if so, the intersection of faster-growing pay and slower inflation has the potential to generate real wage gains and, in so doing, patch the biggest missing piece of the expansion.

To be clear, there are still many people and places who’ve long been left behind, particularly outside of the economically hot urban hubs. And it will take a whole lot of real wage and income gains to make up for decades of often weak middle-class income growth. But current conditions look set to deliver at least some long-awaited real gains.

The problem is that economic policymakers, particularly at the Federal Reserve, must separate heat from overheat.

You can get the gist of what I mean from the opening of a report from MarketWatch on Friday morning’s stock market: “U.S. stocks traded solidly lower Friday … after a report on employment showed healthy wage growth and hiring.”

Say what?! Why should “healthy wage growth and hiring” generate a market sell-off?

Two reasons. First, the stock market prices in future corporate profits, which have, for the record, been crushing it of late. Higher labor costs can, however, cut into profits, so that’s one concern. I’d say that’s misguided, as higher real earnings across the broad middle class means greater consumer demand for the goods and services these companies produce. It’s also evidence of a much broader social, economic and political problem where what’s good for workers is assumed to be bad for companies and financial markets.

The second reason for the postjobs-report sell-off was markets pricing in the possibility that the Federal Reserve would react to the faster wage growth by raising interest rates more quickly than planned, thus slowing the economy and dinging future profitability.

This too may be misguided. At least, I hope it is. The first thing to know is that for more than a year, unemployment has been below the rate the Fed considers to be the lowest jobless rate consistent with stable prices. According to their model, prices and wages should have been shooting up quickly in recent quarters, but the other two lines show that not to be the case. Wage growth is gradually ticking up, and core inflation (which omits volatile and globally determined energy prices), after years of coming in below their 2 percent target, is just now hitting that target.

And there’s one more trend to consider. When thinking about the impact of wages on prices, we must also consider how efficiently firms are producing their output. After all, if workers are more productive on average, then wage growth should be noninflationary, as real pay gains are supported by real output gains.

Thankfully, our good friends at the Bureau of Labor Statistics produce just such a measure. It’s called “unit labor costs,” it is a measure of labor costs per unit of output, and it’s growing smoothly at 2 percent and showing no signs of acceleration. This pattern is totally consistent with stable inflation and a clear sign against any claims of overheating.

For over a year, the Fed has been on a slow and gradual path of steadily tapping the growth brakes by raising the interest rate it controls at a pace of around one point per year. Given how low rates have been, I think that’s a reasonable path as the economy’s closing in on full employment.

But at the same time, it’s extremely important to recognize that if, in fact, there’s an improvement in trend wage growth, that just means that a lot of working people who’ve long been left behind are finally catching a break. To overreact to their long-awaited gains by moving from brake tapping to brake slamming would be a huge, portentous mistake that would only serve to underscore the dangerous yet increasingly pervasive myth that what’s good for workers is bad for the economy.

Tim Brinton