MNI INTERVIEW: Fed Economist: Wage Growth Already Above Trend

--Trend Growth for Wages Lower Today Vs Pre-Crisis, SF Fed's Mary Daly Tells MNI

--Shifting Workforce Composition, Slow Productivity Growth, Low Inflation

Depress Wages

By Jean Yung

     WASHINGTON (MNI) - Wage growth has picked up and already exceeded its new

normal trend rate as the unemployment rate has fallen, offering further evidence

there is limited slack in the labor force, Mary Daly, a labor economist and the

director of economic research at the Federal Reserve Bank of San Francisco, told

MNI in an exclusive interview. 

     The jobless rate is half a percentage point below its estimated natural

rate but wage growth has been muted at around 2.5% per year, compared to the

roughly 3.5% seen the last time unemployment was this low. Does that mean the

signal has been muddled or is there more slack out there than policymakers

thought? 

     Daly's research found the former explanation more likely. Taking into

account the changing composition of the American workforce, low productivity

gains and below-target inflation, "I would say we're seeing a pick-up in wage

growth above its trend level, because we've already hit the rate we had before

the crisis," Daly said.  

     "Wage growth of 2.5% wouldn't surprise me for a while. Getting up past 3% I

think would challenging in the long haul," she said, referring to a measure of

median weekly earnings constructed in-house at the Fed bank that is closely

related to the median weekly earnings series reported quarterly by the Bureau of

Labor Statistics. 

     Under Chair Janet Yellen's leadership, the Fed waited to raise interest

rates to bolster the economy. That appeared to pay off: Individuals who weren't

working or looking for a job have been coming off the sidelines to rejoin the

labor market. The labor force participation rate, which fell four-tenths to

62.7% in October but has been relatively steady over the past two years,

continues to buck its estimated long-term trend, Daly noted. 

     "Labor force participation has been relatively flat when we would expect it

to be coming down, so that means we have cyclical reentry of workers," she said.

"It's a good thing for the labor market. It signals strength. But that's a

reason we might not be able to trust the aggregate wage growth measure as a

strict indicator of full employment." 

     Her team pinpointed several compositional shifts in the labor force as key

reasons why aggregate measures of wage growth have been so disappointing.   

     The retirement of high-wage baby boomers, reentry of long-term unemployed

and the entry of younger workers -- two groups that tend to earn lower wages --

are shaving about a percentage point off median weekly earnings growth right

now, Daly said. 

     She judges that slightly more than half of the compositional shift is

transitory while the remaining is persistent, shaving half a percentage point

off trend growth in wages over the long haul. 

     "My best forecast is over the next year -- by the end of 2018 or before --

the effects of the increase in labor force participation is going to diminish,"

she said. "But the baby boomers will continue to retire, and the net replacement

will be a net reduction in wage growth," likely for another decade. 

     By looking only at the wage growth of continuously full-time employed

workers, which isolates the compositional effects, Daly found that that rate is

already back where it was before the financial crisis. 

     "We've made a full cyclical recovery in full-time worker wage growth, which

is in my mind a very good measure of how strong the labor market is," she said.

     But in the long run, the potential for nominal wage growth requires a rise

in productivity and in inflation, she cautioned. The San Francisco Fed projects

trend economic growth at just 1.5% per year, one of the most pessimistic

outlooks among the Fed banks. 

     "With productivity growth lower than 1% and inflation lower than 2%, it's

going to put downward pressure on the aggregate wage growth number," Daly said. 

     Data out of BLS last week showed nonfarm labor productivity jumped 3.0%,

rising at its fastest pace in three years, in the third quarter. But Daly said

even if trend productivity picks up for good, which history illustrates is

difficult for economists to forecast, employers are very slow to respond with

raises because raises cannot be easily rolled back. 

     "You wouldn't just have a couple months of good data. You'd have to see it

move up and stay up and you'd have to see commentary saying this is the new

normal," before it translates to wage growth. 

--MNI Washington Bureau; +1 202-371-2121; email: jean.yung@marketnews.com

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