MNI INTERVIEW: Rising US Productivity Keeps Wages Sustainable

Rising productivity allows the U.S. economy to maintain a higher level of wage growth that is still consistent with stable prices and can help deliver a labor market soft landing, Kevin Rinz, a former White House economist who was also a visiting scholar at the Federal Reserve Bank of Minneapolis, told MNI.

"If labor productivity is growing, wages can grow without causing problems for inflation," he said in the latest episode of MNI's FedSpeak Podcast. "Those two things had been a bit out of whack over over the last year-and-a-half or so, with wage growth exceeding productivity growth pretty substantially. But now, they seem to be back in line, so that we're getting roughly the wage growth that you would expect to see given productivity growth and a 2% inflation target." (See: MNI INTERVIEW: Hot US Economy Complicates Fed Cut Calculus)

The FOMC would likely want to see some further slowing in wage growth before it gains the confidence on inflation needed to lower rates, but higher productivity will be a key argument in convincing the central bank that there's little risk of a wage-price spiral, Rinz said.

Wage gains during the pandemic were the highest at any point since the early 2000s and, while pay growth has eased over the past year, it remains higher than what is consistent with a 2% inflation target amid a still-hot labor market, he added.

"If you're thinking about whether the labor market we have is one that is sustainable, maybe you want to see a little bit of some slowing down of wage growth," Rinz said.

MORE OUTPUT PER WORKER

Compensation costs for civilian workers increased 4.2% for the 12 months through December, down from a peak of 5.1% in 2022, as measured by the Labor Department's Employment Cost Index. In January, average hourly earnings grew another 0.5%, lifting the 12-month rate to a higher-than-expected 4.5%.

Fed Chair Jerome Powell has said annual pay increases of around 3.5% would be consistent with stable prices, but that figure could be higher if productivity has risen, Rinz said. That's because productivity improvements can help temper concerns that higher wages will feed through to prices, he said.

"Going back to this productivity issue is a big point for me. As long as we see continued balance with productivity growth, I'm not super worried about wage growth continuing to make big contributions to inflation," he said.

Since the pandemic, productivity has fluctuated widely as workers shifted between sectors and firms adapted to changing demand patterns. After contracting in 2022, labor productivity for nonfarm businesses accelerated to a 3.2% annualized rate in the fourth quarter and a 12-month rate of 2.7%. Unit labor costs gained only 0.5% in the fourth quarter, down from 2.3% a year ago.

SUSTAINABLY STRONG

More broadly, a range of indicators on the U.S. labor market suggest it's tight but not unsustainably so, Rinz argued. The unemployment rate, labor force participation rate, job openings and layoffs data are all at the strong end of where they've been over the past two decades or so and similar to where they were pre-pandemic.

Meanwhile, solid fundamentals underpin the current labor market strength, and Fed rate cuts starting later this year should help sustain its strength, Rinz said. Hire rates and job openings have been somewhat slower over the past several months, which he said makes sense if firms have fewer workers to replace because fewer of them are quitting or being laid off.

"While job growth has been faster than usual, that strength is not built on anything particularly unusual happening," he said. "If we ended up seeing that wages and productivity continue to align, and that relieves some concern about inflation, maybe that could give firms a more secure feeling about hiring."