Real Wages Are Finally (Finally!) Growing. Can the Fed Stop Itself From Ruining Everything?

Of all the countless ways to measure the health of the economy, one stands out as the most meaningful for American workers: Average real (i.e., accounting for inflation) weekly earnings. How much food can the average paycheck buy compared to a year ago? How much of the rent or mortgage can it pay? How much of the basic necessities can that paycheck cover? The answer to that question tells us how well the economy is doing for average Americans right now.

The Great Recession absolutely killed American paychecks. The National Employment Law Project found that workers' real earnings actually dropped from 2009 to 2014. More broadly, the chart below the fold tracks real weekly earnings for production and non-supervisory employees going back 50 years. After peaking in the early 1970s (Nixon was a liberal on economic policy, after all), they bottomed out under George H.W. Bush, stayed flat a few years, and then started improving sharply during Bill Clinton's presidency.

What's most important right now is that, after five bad years following 2009, real weekly earnings are now, finally, improving again, up 2.2 percent from July 2014 to July 2015. That's an impressive jump, and, amazingly, they are at a high not seen since 1980. This fact that shows how devastating high inflation has been for American workers, as seen in the huge drops in real earnings that coincided with double-digit inflation in 1974 and from 1979 to 1981. Furthermore, these recent gains are even stronger at the bottom of the wage scale according to a number of measures, thanks in part to increases in the minimum wage that progressives have won.

Let's be clear about something. Real weekly earnings should be increasing over time. Why? Because worker productivity has been going up, and so have profits. Why in the world shouldn't workers take home a commensurate share of the rewards their work produces? For the last four decades, however, they haven't. When the Federal Reserve Board meets in just a few days, they will have a chance to either nurture the positive trend of the past twelve months, or drive a stake right through it.

The Federal Reserve is a complicated beast. In simple terms, the law gives it a dual mandate when it comes to setting interest rates and other policies. The Fed must try to encourage maximum employment and seek stable prices. These two goals can conflict with one another. Maximum employment and a tight labor market typically lead to wage increases, but too much of that good thing can then spark inflation, which is the usual justification for the Fed to raise interest rates.

Interest rates have been very low for a very long time, and with good reason. Low rates plus the stimulus from the Fed's Quantitative Easing program (which tapered off and ended last October) helped stimulate the economy after the 2008 crash. In fact, once the Republicans not only blocked further direct stimulus spending after 2010 but managed, through the sequester, to impose austerity, the Fed's measures became even more vital. The Fed brought its federal funds rate to just above zero in December 2008, and has left it there ever since. Obviously, it can't stay there forever. The question is: When should the Fed start raising the rate?

My answer, my argument, my plea to the Fed is this: Not yet. Yes, we have wage growth over the past 12 months, and we've had strong job growth in recent years. But that in itself is not a reason to raise rates and choke off this vital growth that's combating the income inequality that has plagued our economy for four decades. The Fed is charged with pursuing stable prices, right? Well, we've got 'em, folks.

Inflation is essentially non-existent right now. Overall inflation ran below zero from January through May of 2015, meaning prices actually dropped. Even after slight increases in June and July, inflation remains in negative territory for the year. Furthermore, although we don't yet have overall numbers for August--they'll be released on September 16 while the Fed is meeting--prices for U.S. imports dropped 1.8 percent for the month, and dropped 0.4 percent even when excluding the volatile fuel sector. Prices are stable.

The problem is that even though the Fed is supposed to pursue both maximum employment and stable prices, the latter concern often wins out. As Mark Thoma at The Fiscal Times explained:

The inflation problems of the 1970s, the loss of Fed credibility that came with it, and the need to impose the Volcker recession in the early 1980s to bring inflation down to tolerable levels made an indelible impression on policymakers who lived through that time period. The Fed's trigger-happy response to any suggestion of an inflation problem is directly related to the desire to never let such an inflation outburst happen again.

But it has been more than four decades since the beginning of the inflation problems of the 1970s, and the economic environment in which monetary policy operates has changed considerably since that time. Those changes support patience, particularly in response to increases in wages, wages that have been stagnant since the 1970s even as labor productivity has been increasing.

In a Bloomberg TV interview, Paul Krugman counseled patience as well:

If the Fed waits too long to raise rates, then we get a little bit of inflation. If the Fed raises rates too soon, we risk getting caught in another lost decade. So the risks are hugely asymmetric. I really find it quite mysterious that the Fed is eager to raise rates given that, they're going to be wrong one way or the other, we just don't know which way. But the costs of being wrong in one direction are so much higher than the costs of being the other.

I do believe that Janet Yellen--the most progressive-minded economist to serve as Fed Chair in many decades--wants to see the paychecks of workers increase as much as possible without setting off the kind of inflation that can ultimately devastate those very same workers. I'm not saying her job is an easy one.

Nevertheless, the evidence is clear. Wages are rising, finally, and prices are not--a rare confluence in recent decades. American workers need this to continue as long as possible. So do their bosses, in fact, because workers are the consumers that drive economic growth and thus corporate profits. Earnings lead to spending, which, hopefully, leads to more earnings. That's what economists call a virtuous cycle. When inflation does rise, the Fed will, unfortunately, have to act. However: We're not there yet.