Especially since major U.S. stock indices hit their March, 2009 bottom, it’s been clear that U.S. businesses have learned how to thrive without strong personal consumption in America or even anywhere in the world. They could sell to governments and to other businesses, and most of all, they could ring higher profits out of greater efficiencies.
This afternoon, the new minutes of the latest (July 29-30) Federal Reserve Open Market Committee meeting posed a new, much more interesting question: How can the U.S. economy nowadays prosper without a reasonably strong American consumer?
Not that the question was explicitly asked by Federal Reserve’s staff or the governors or regional Fed bank presidents comprising the FOMC. But it came up nonetheless in the minutes’ description of these participants’ views on the current state and outlook for the economy. According to the minutes, “a couple of” these Fed leaders “indicated that the pass-through of labor costs has been more attenuated since the mid-1980s and that wage pressures might not be a reliable leading indicator of higher inflation.”
These comments came amid what seems to have been a pretty vigorous debate over whether the U.S. job market is improving enough to justify the start of monetary policy normalization sooner rather than later. The stakes couldn’t be higher, since – at least as the Fed participants and many others see it – starting to raise interest rates too soon too fast from years at just about zero could choke off a U.S. economic recovery widely seen as far too feeble. Yet postponing rate hikes too long or raising them too slowly could risk economic overheating and worrisome inflation. (A pretty large minority of economic observers views the Fed’s policies as a big part of the problem, and insists that growth and hiring can’t become satisfactory as long as super easy money keeps encouraging too much outright speculation and other unproductive uses of capital.)
Wages have become crucial in this debate because historically when they have started rising strongly, broader inflation hasn’t been far behind. The reason: Although they help foster growth, the resulting higher levels of demand and consuming can spark a vicious cycle in which businesses recognize the leeway to raise prices, these price increases feed pressure for more wage hikes, and so on.
At the same time, although the headline unemployment rate has been falling faster than the Fed consensus has expected, wages have remained weak – which has prompted monetary “doves” to doubt how tight the job market, and underlying economic activity, could actually be. As this faction sees it, wages are but one of a set of indicators other than the headline jobless rate that needs to be improving before real labor market health and broader economic vigor can be considered restored, and before inflation watchfulness will become reasonable.
The above “pass through” point seems to have been made by Fed hawks pushing for higher rates. (The initially released form of the minutes discretely keeps the sources of all individual comments confidential. We won’t know who exactly said what until the full version is released – five years from now.) So what if there’s no wage inflation, they appear to be asking. Inflation can strengthen dangerously without it.
Yet what they now need to explain is how — given circumstances today and likely for the foreseeable future. For assuming that economy-wide inflation can take off without wages substantially above today’s historically modest level seems to assume that growth can become truly robust even though the median American worker’s pay is barely keeping up with the prices of what he or she needs or wants to buy. In other words, it seems to assume either that workers will be able to maintain and even increase their consumption despite flat-lining paychecks, or that some other huge source of demand for American business’ output will appear.
Irrespective of economy-wide growth, prices can certainly surge in certain parts of the economy when credit or other forms of buying power specific to those sectors becomes too abundant. Think of the housing price bubble of the previous decade – which was by no means accompanied by record peacetime overall economic growth – the higher education cost bubble inflated greatly by student loan availability, and longstanding health care cost inflation fueled by massive government subsidies.
Economy-wide inflation largely or partly disconnected from wage inflation isn’t unprecedented, either. For example, during the 1970s, much inflation stemmed from big hikes in the price of imported oil. But these increases had nothing to do with monetary policy, and little to do with the economy’s overall level of activity. They came from a foreign producers’ cartel starting to flex its muscles. Similarly, prices of agricultural commodities can rise quickly – for a while – simply because of bad weather.
Yet aside from this type of commodity inflation, nothing capable of generating significantly faster economy-wide growth without significantly better paid American workers seems visible today. America’s rich and super-rich of course continue to fare increasingly well. But the higher incomes rise, the less consumption proportionately is spurred by this income. So the one percenters and even the ten percenters won’t be able to boost economy-wide demand enough to support a much stronger recovery.
During the bubble decade, Washington enabled lower-income Americans to consume strongly despite stagnating pay by showering them with credit (i.e., the housing finance model was extended to the entire economy). Yet since this strategy nearly collapsed the entire world economy and triggered the worst national and global recessions in decades, don’t expect a replay (at least not right away).
As indicated above, American business could sell to other American businesses. But at some point, many of these businesses need to sell to those struggling consumers, or else they’ll stop buying machinery, materials, and other producer goods. Nor is it likely that foreign demand can adequately supplement, much less replace, currently subdued domestic demand. Even in good global times, other countries’ consumers and businesses never acted crazy about Buying American – at least on the all-important net basis. During a slower growth era, they’ll undoubtedly continue import even less enthusiastically.
This doesn’t mean I’m endorsing later rather than earlier tightening, or even looser money, or various other non-monetary policy demand-boosting proposals like raising the minimum wage or further extending unemployment benefits. (I’m not necessarily opposing any of them, either. That’s not the point of this post.) It doesn’t mean that I’m blasé about inflation. Nor am I coming down definitively on the cosmic question of whether demand ultimately produces supply or vice versa.
Instead, I’m saying that, contrary to Fed hawks, adequate U.S. economic growth without much better wage growth is a mirage. The sooner the Fed – and the rest of the federal government – recognizes this, the faster real recovery will arrive.