Friday, August 8, 2014

Growth in Wages May Increase Pressure From Inflation Hawks In Central Banks

Central banks have a dual mission: they want to keep the inflation rate around a target rate of 2%; they also want to avoid recessions.  A slight increase in the rate of wage growth in the US and in the UK has encouraged inflation central bankers, who worry primarily about inflation, to advocate an increase in interest rates.  Growth in real wages will stimulate consumption and increase the risk of inflation.  This article argues that growth in real wages would be good for the economy and that the risk of inflation is not high in our current situation.  The article also reminds us that we had rapid wage growth, low unemployment and negligible inflation during the Clinton Administration. That happy situation led to the only federal budget surpluses in our recent history.

This post raises more general questions about wage growth and economic policies.  Economic policy in Europe, for example, has been driven by constraint in wage growth.  The assumption is that cost reductions will lead to export driven economic growth.  Its also possible to stimulate domestic demand by providing households with higher wages.  That strategy is not popular with business leaders, particularly in the US.  The growth in corporate profits in the US is highly correlated with stagnant growth in wages.  That could stimulate the economy if corporations invested their profits, but corporate investment as a percent of GDP has been tracking downward during the recovery.  Corporations have found other uses for their profits.  They have been increasing dividends to shareholders and buying back their own stock.  They have also been trying to grow corporate revenues through acquisitions and mergers.  The slow recovery in the US has been constrained by slow growth in personal consumption and by slow growth in business investment.  Fiscal policy has also been a problem.  Government spending as a percent of GDP is well below the trend that it was on during the previous 15 years.

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