It Really Seems as Though Dallas Fed President Richard Fisher Doesn’t Want Real Wages to Increase, or Doesn’t Believe Real Wages Can Increase, or Something: Tuesday Focus for September 23, 2014

Tim Duy: Fisher on Wages: “Richard Fisher said Friday the US economy was threatened…

…by higher wages. Via Reuters:

Fisher said on Friday he worries that further declines in unemployment nationally could lead to broader wage inflation. To head that off, and also to address what he called rising excesses in financial markets, Fisher said he prefers to raise rates by springtime, sooner than many investors currently anticipate….

I wondered if he was not misquoted or misinterpreted. But he definitely warns that wage growth is set to accelerate in his Fox News interview…. The crux of his argument is that wage growth accelerates when unemployment hits 6.1%…. He seems genuinely concerned that wage growth is negative outcome–that wage growth in Texas is a precursor to a terrible outcome for the US economy as a whole. His entire tone is odd, and I feel compelled to clean up his argument…. It is reasonable to expect that wage growth will accelerate as unemployment moves below 6%… [although] this is… a test of… [whether] alternative measures of under-utilization more accurately… [measure] slack…. That said, why should Fisher fear wage growth? I don’t see how one can expect real wages to rise in the absence of nominal wage growth in excess of inflation. And once you accept the possibility of real wage growth, you recognize the link between wage growth and inflation could be very weak. And so it is….

The past 20 years give no reason to believe that 4% wage inflation cannot happily coexist with 2% price inflation. So if wage inflation does not necessarily translate into price inflation, why worry at all? Why is Fisher even worried about wages? The key is really just this quote:

This is like duck hunting, you shoot ahead of the mallard rather than try to get it from behind, otherwise you can’t hit it.

It is all about the timing…. Rather than act disgusted by higher wage growth, he should say that the Fed needs to ensure that such growth translates into real wage growth, and the Fed accomplishes this by adjusting accommodation to maintain its price inflation target. The Fed wants to hold unemployment in a zone consistent with both real wage growth and low and stable inflation. This requires nominal wage growth in excess of 2%. It follows then that given the unemployment rate is already near 6%, it is not reasonable for the Fed to suggest that the first rate hike is a ‘considerable period’ off…. Stated like this, I suspect a large portion of the FOMC would be sympathetic…. That said, most members lack Fisher’s certainty that wages gains are set to accelerate and indicate that labor market slack has dwindled to the point that it is appropriate to remove financial accommodation. There remains the concern that the unemployment rate is not the best measure of labor market slack…. Moreover, as we now know, showing their anti-inflationary resolve did not do the Fed any favors in 2006 and 2007…. It is reasonable to thus conclude that on average, the Fed has been too tight, not too loose. Hence again why the FOMC is willing to be patient in the normalization process….

I suspect that Fisher has pivoted to concerns about wage inflation because his much feared price inflation has never emerged…

As I said yesterday, there is great uncertainty right now whether the right measure of current macroeconomic slack is something like the unemployment rate or something like the employment-to-population ratio. And the two possibilities produce, via Okun’s Law, very different pictures of how much slack there currently is between current levels of output and employment and potential output and full employment:

4% per year nominal wage growth is not a problem as long as it is accompanied by 2%/year increases in prices. In fact, that is the configuration we want to see. And that is the configuration we saw in 1989-1990, 1997-2000, and 2006-2008. And in all three of those episodes it turned out after the fact that urgent tightening of monetary policy then was not what the economy needed–the Fed tightened in 1990-91, and found that it had overdone it when the S&L bankruptcy shock hit financial markets; the Fed tightened in 1999 and refused to loosen in 2000, and found that it had overdone it as tech investment collapsed; the Fed tightened in 2006-2007, and…

By contrast, 2%/year nominal wage growth is a problem: it is accompanied either by sharply widening income inequality or by downward pressure pushing inflation toward and perhaps below 0%/year. And an inflation rate that continually undershoots the Federal Reserve’s 2%/year target (which really ought to be 3% or 4%/year) leaves the economy very vulnerable to any additional negative shocks that might occur, and they will. Federal Reserve policymakers who fear the risks associated with prolonged intervals of very low interest rates really should, right now, by stridently advocating for monetary policies that will get us to 4%/year wage inflation as fast as possible. But they are not. It is a puzzlement…