Why economists want the Fed to let wages rise

Data: Household income from U.S. Census Bureau; GDP from Bureau of Economic Analysis. Note: Income is inflation adjusted to 2018 dollars and GDP is adjusted to 2012 dollars. Chart: Kerrie Vila/Axios

With roaring GDP growth and rising wages, the Fed has signaled that it will increase interests rates next month to tap the brakes and prevent uncontrolled inflation. But some economists say it should hold off to create a better chance for people's wages to go up.

Why it matters: For the last five decades, real U.S. household income for the bottom four quintiles has been flat or almost flat, as the graphic shows. The top group, however, has had sharply ascending real income growth. The flat wages are a bigger problem at the moment than the threat of inflation, these economists suggest.

The big picture: This view is grounded in the thought that the Fed's current approach — shaped by the era of "stagflation" in the late 1970s and early '80s — may be outdated.

  • The Fed "should go slowly on closing the locks because wages are barely rising at this point," David Autor, an influential economist at MIT, tells Axios.
  • "There's further room for the tides to rise so that all boats will be lifted (including but not limited to the vessel of middle-wage earners, though an even greater concern is for low-wage earners)."

The Fed has already raised rates twice this year, and most mainstream economists think it will do so again in September and December. They also expect three interest rate hikes next year, pushing it over 3%.

  • This should have the impact of slowing wage growth by making it more expensive for businesses to borrow money.
  • But the question is whether the Fed should hold off on a rate increase and first give the opportunity for wages to rise more.

Not everyone is convinced of the Fed's power to impact real wages even if it wants to. "It is difficult if not impossible for the Fed to control what workers earn above and beyond inflation," said Benn Steil, an economist with the Council on Foreign Relations.

But economic orthodoxy presumes the Fed influences both wages and prices, and there appears to be much support among mainstream economists for the bank's current policy track of steadily raising interest rates.

  • Economists tell Axios that wages will probably rise despite the rate hikes.
  • Jared Bernstein, a fellow at the Center on Budget and Policy Priorities and former chief economist to Vice President Joe Biden, said real wage growth could come if inflation slows — for instance, if surging oil prices flatten and come down.

But Joe Brusuelas, chief economist at RSM, a consulting firm, tells Axios that while he expects real wage growth along with higher interest rates, "The Fed should consider dropping the Carter era discourse and policy rules of thumb."

  • "The term 'wage inflation' is an archaic notion left over from the 'great inflation' period of the 1970s," he said in an email. "While it’s important to learn from and know history, it’s equally important not to become its prisoner. 
  • "We have experienced a great structural change in our economy and the arrival of digital economics requires a different discourse, policy judgement and quantitative rigor."