Despite Stagnate Wages, Feds Still Fear Wage Spiral

The surges this year in oil and food prices could not have come at a worse moment for the typical American worker, who has not had a raise to speak of in this decade.

Workers’ leverage is gone. Companies are not creating jobs. Unions that negotiated big wage increases in the 1970s are shadows of their former selves. Cost-of-living adjustments, once commonplace, have disappeared. And the movement of jobs offshore, or the threat of it, has conditioned workers to not even ask for a raise, fearing they will join the millions already laid off.

CNBC.com

Still, the Federal Reserve’s policy makers — its governors and the presidents of its regional banks — are convinced that wage pressures could emerge unexpectedly. That concern, and the idea that wage pressures could lead to yet higher prices and a rising inflation rate, showed up in half-a-dozen interviews with policy makers over the last week.

The policy makers assume that rational human beings, faced with higher prices, eventually demand and get higher pay, despite their apparent lack of leverage. They have built that assumption into their economic models, but they differ sharply on how quickly the wage pressure could resurface, an issue they will once again debate at their next meeting, on Tuesday.

“The power to bargain for higher wages, a power that we assume was dismantled, may not be so feeble,” said Richard W. Fisher, president of the Federal Reserve Bank of Dallas, who is the most certain of all that a wage-price spiral is imminent.

If the Fed anticipates a reawakening, organized labor itself certainly does not.

“Real wages, adjusted for inflation, are falling, and there is no sign at all of any change in direction,” said Ronald Blackwell, chief economist for the A.F.L.-C.I.O., offering a view shared by Nigel Gault, chief domestic economist for Global Insight, a Wall Street firm, who argues that if prices go up, people will expect not a raise, but “their standard of living to go down.”

The issue to be debated by policy makers, who recently finished slashing interest rates in response to the credit crisis and the economic downturn, is how quickly wage pressures could resurface.

In the Fed’s playbook, employers would grant raises in response to the pressure and then seek to recover the costs of those raises by jacking up prices for a range of everyday items.

Their price increases would be followed, again according to the Fed’s playbook, with another round of wage increases, to be followed in turn by another round of price increases, setting off a wage-price spiral that would be difficult for the Fed to undo.

Just such a spiral drove up the inflation rate in the 1970s, during the first great oil price surge, and it haunts the policy makers to this day. Paul Volcker, then the Fed chairman, finally broke the spiral by pushing interest rates ever higher, precipitating the harsh 1981-2 recession.

Inflation and wage demands have remained relatively subdued ever since, but that cannot last in the teeth of another oil price shock, in the view of the current policy makers, who see themselves as Mr. Volcker’s spiritual heirs.

Some policy makers are much more convinced than others that a modern-day version of the 1970s experience is not only possible but imminent, and they insist that interest rates must go up now to snuff it out, even at the expense of further weakening an already damaged economy.

Mr. Fisher, who has voted at past meetings to raise rates, sometimes casting a lone vote, argued in an interview that wages are rising for others around the world, particularly in Asia, and “American workers will react” by demanding higher pay for themselves.

“I am concerned,” he said, “that at some point they will have to be accommodated because they can’t afford the rising costs of gasoline, food, utilities” and other everyday expenses.

That view finds support among economists on Wall Street and at think tanks in Washington.

“If American households are losing ground to inflation,” said Adam S. Posen, deputy director of the Peterson Institute for International Economics in Washington, “and they can’t resort to automatic cost-of-living adjustments or union power, they’ll find some other way, through their demands on the political process and through their expectations.”