Wage Jump Sparks Worries Inflation Is Catching Fire

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Wages rose in the first quarter at the fastest pace in 14 years, and economists say this type of inflation likely won’t be the “transitory” (temporary) kind the Federal Reserve is counting on to maintain its easy monetary policy.

The Employment Cost Index (ECI), a broad measure of labor costs, jumped 0.9% on a seasonally adjusted basis last quarter after gaining 0.7% in the final three months of 2020, the Bureau of Labor Statistics said Friday. That was the fastest growth since the second quarter of 2007 and topped consensus estimates for a 0.7% rise, according to Moody’s Analytics. For the 12 months ended March 31, ECI rose 2.6% from 2.5% in the fourth quarter.

The increase in wages comes amid a labor shortage. Even with millions of people still out of work, companies have said they’re having a hard time finding workers. To attract employees,  businesses are increasing pay, which economists say may end up making inflation “stickier” than what the Federal Reserve has been banking on to keep monetary policy loose. Wages are hard to cut, so if they continue to rise, economists believe this could lead to the Fed tightening monetary policy—in other words, raising rates—earlier than expected.

Inflation matters because it can drive up the prices of everyday goods and reduce consumer purchasing power. The money in people’s wallets—and savings accounts—loses value and can buy less. While an interest-rate hike could curb inflation, it could also slow down economic growth because it increases the cost of borrowing for everything from cars and homes to money to grow companies.

After last Wednesday’s Federal Open Market Committee meeting, Fed Chairman Jerome Powell acknowledged the difficulty businesses were having finding workers. However, he noted that “we don’t see wages moving up yet, and presumably we would see that in a really tight labor market.” He said wages might increase but continued to seem unconcerned, reiterating that inflation pressures would likely be “transitory,” or short-lived. 

He may have spoken too soon.

“Price pressures are spreading to the jobs market,” ING Chief International Economist James Knightley wrote in a report. “This is typically viewed as a signal that inflation could be stickier over the longer term.

Most economists and the Fed expect the tightening of the labor market to ease in coming months as the pandemic fades, schools and summer programs reopen for kids, parents get back to work, and fiscal support including unemployment insurance fades. But all that may not come soon enough, prompting businesses to increase pay as a last resort.

“The Fed believes that the inflation bump we are about to see in the spring data will be transitory,” said BMO Chief Economist Douglas Porter in a research report. “Well, yes, but an earthquake is also transitory.” In other words: The economy may feel the effects of the increase in inflation, even after the first jolt passes.