Inflation Threat Increases as Labor Market Tightens : Pressure to Raise Wages Is Growing

Wage increases have been small in recent years--but that trend might change soon if employers continue to hire at the same rate they have been in recent months, economists say.

American workers have grown accustomed to low pay raises in recent years--4% or less on average, just about enough to keep up with the inflation rate.

But some analysts worry that wages might begin to push prices higher throughout the economy if labor markets remain tight. Last week, unemployment was reported at a four-year low of 5.8%. “The conventional American family is fully employed by any standard,” says Roger Kubarych, general manager of Henry Kaufman & Co., an economic consulting firm.

Rising employment alone is no problem if workers produce more. But if wages rise faster than output, there is more money chasing fewer goods, and that, inevitably, translates to higher rates of inflation.

The threat of a renewed bout of wage inflation has grown, given continued evidence that the U.S. economy is at or close to full employment, say several economists.

Moreover, should wage inflation take hold, monetary policy would have to become much tighter, raising the risk of a boom-bust cycle.

“If demand holds up enough to keep the unemployment rate in its present neighborhood, we’re going to see gradually rising inflation,” says Edmund Phelps, economics professor at Columbia University.

Phelps, a top researcher on macroeconomic trends, says the current unemployment rate is well below its natural rate, or the point at which wage pressures typically develop.

Under such conditions, employers gradually pay more to line up hard-to-find workers, having exhausted other avenues of cost control. Average hourly earnings, a key barometer of wage demand, rose 0.7% in October, the highest increase in 11 years.

Recent evidence shows prices of raw materials are already on the rise, but the restrained wages have lulled some into thinking inflation will not be a problem, Phelps said.

There is “a fallacy--namely, that if you have faster productivity growth, you can have lower unemployment as a steady proposition,” he said.

Indeed, the demand for workers can continue to rise, and if the supply runs short, wages will rise, whether there are productivity gains or not, Phelps said.