Wage growth is slowing. Job openings are increasing, unemployment is holding, and wage growth is slowing. This was supposed to be impossible–so what does it mean that it’s happening?
Throughout the inflationary period of the pandemic recovery, there has been a common refrain from many macro commentators: the only way to get inflation down is to lower the rate of wage growth, and the only way to do that is by increasing unemployment and cutting workers’ bargaining power. Inflation, in this view, is caused by excess wage increases that are themselves “caused by” the low level of unemployment. Yet the Q4 Employment Cost Index report is showing that one of the most empirically robust measures of wage growth is slowing just as the unprecedented job growth of the pandemic recovery tapers off and unemployment rates fell to historic lows.
Over the last fifteen months, economists have increasingly stated or implied that the only way to get inflation under control is by increasing unemployment. It is true that a soft ECI print is not yet clear proof of victory on inflation. However, it is a bright sign of plausibility: unemployment rate increases are not a necessary condition for wages or prices to decelerate.
The Fed should consider a wait-and-see approach for any further hikes beyond tomorrow. It bears repeating that, when the Fed throws people out of work at a recessionary scale, there are investment and growth costs to the macroeconomy, and unnecessary disaster for millions of individual workers. Without staking out any arguments about the long-term behavior of wage growth and productivity (the residual of output divided by hours worked, a measure about which we have registered skepticism), commentators and policymakers should use this new datapoint to reassess the amount of labor market pain that is “necessary” to resolve inflation.
Now, that “necessary” amount of pain has varied substantially over time. Some economists have claimed that responses as severe as “10% unemployment for one year” or unemployment at “6.5% in 2023 and 2024” to bring inflation down to a 2% level. These are astounding amounts of labor market pain, with the former roughly matching the peak unemployment of the Great Recession, and the latter indicating millions of lost jobs. This ECI print should be evidence that we need not force more pain to see the kind of wage slowdown these economists believe necessary for disinflation to take hold.
In December of last year, their Statement of Economic Projections showed unemployment increasing by more than 1% in the coming year. Increases of that size have always triggered a recession in a modern economy.
Yet for each of these commentators, the idea that wage growth (and eventually inflation) could soften meaningfully without labor market pain seemed vanishingly unlikely. While we have not seen inflation stability yet, we have the wage deceleration that – in the view of many economists and commentators – would have been the goal of increasing unemployment in the first place. Why increase unemployment if you don’t have to?