When it comes to U.S. economic growth, wages may never have been this important.
The link between earnings and consumer spending has been tighter in this expansion than in any other since records began in the 1960s, according to calculations by Tom Porcelli, chief U.S. economist at RBC Capital Markets LLC in New York.
Wages have become even more critical as households, still shaken after being caught with too much debt when the recession hit, remain unwilling or unable to tap home equity or let credit-card balances balloon to buy that new television or dishwasher. By not overextending themselves again, Americans are only spending as much as their incomes will allow, meaning that 70 percent of the economy is riding on how fast pay rises.
“In an environment where credit is not being used in a material way, the fate of wages matters,” Porcelli said. “They’re doing all of the driving from a consumption perspective.”
The correlation between growth in wages and consumer spending adjusted for inflation stands at 0.93 since June 2009, when the recovery began, according to Porcelli. A reading of 1 means they move in the same direction all the time, zero means there is little relationship and minus 1 means they continually diverge.
Porcelli tracked wages through the index of aggregate weekly payrolls for private production workers, which takes into account hourly earnings, the length of the workweek and changes in employment for about 80 percent of the labor force. Records go back to 1964, longer than the measure for all employees that includes supervisors, which dates back only to 2006.
The outlook for earnings is among the things that will help policy makers decide when to raise interest rates, Federal Reserve Chair Janet Yellen said Wednesday. The labor market has improved enough for central bank officials to prepare to exit the most aggressive easing in the central bank’s 100-year history, though too-low inflation and weak pay gains are reasons for caution.
“We will be looking at wage growth,” Yellen said during a press conference following the central bank’s announcement that it was leaving its benchmark rate near zero. While faster increases in income aren’t a precondition for raising rates, “that would be at least a symptom that inflation would likely move up over time,” she said.
Fed policy makers reduced their forecasts for how quickly they will raise interest rates this year and next and also lowered the projected rate of economic growth.
One reason why officials will be slow to increase borrowing costs is “the residual effects of the financial crisis, which are likely to continue to constrain spending and credit availability for some time,” Yellen said in their press conference.
Six years into the U.S. economic expansion, Americans are still shying away from credit. As of the fourth quarter, total household indebtedness was $11.83 trillion, up 1 percent from the previous three months, according to data from the Federal Reserve Bank of New York. That remains short of the record $12.7 trillion reached in the third quarter of 2008.
Credit-card balances totaled $700 billion in the fourth quarter, little changed from the average of $703 billion for the economic expansion.
“I have been impressed with how reluctant consumers are to increase their debt on especially credit cards,” Richard Curtin, director of the University of Michigan Survey of Consumers, said on a conference call last week. “I wouldn’t expect a sharp increase in credit-card debt, and that’s going to limit spending at the retail level.”
Last week’s report showed the University of Michigan’s preliminary consumer sentiment reading for this month dropped as home-heating bills came due following the plunge in temperatures during February.
Shaka Asuma, 45, of Waldorf, Maryland, is among those shunning debt. He doesn’t have any credit cards, and depends solely on his income to drive purchases.
“I try to spend within my means,” said Asuma, who works in facilities at a law firm in Washington. Most of his salary goes toward paying for transportation to work, groceries and bills. If anything is left over, he might splurge on a game for his Microsoft Corp. Xbox console, Asuma said.
“I don’t like owing money,” said Asuma. “I didn’t want to get a credit card just because I didn’t want to put myself in a predicament where I was tempted.”
Another reason wages are key to the outlook is that homeowners are reluctant to use home equity to boost spending. An estimated $6.7 billion was taken out during refinancing of conventional prime mortgages in the fourth quarter, down from $7.6 billion in the previous three months, according to figures from McLean, Virginia-based Freddie Mac. Adjusted for inflation, so-called cash-out home refinancing reached a peak of $99 billion in the second quarter of 2006.
The amount of debt outstanding equaled a little more than total disposable income in the fourth quarter, the smallest ratio since 2002, according to data compiled by Bloomberg.
The smaller debt loads are, on balance, an advantage when compared to the excesses that sparked the financial crisis, said Dana Saporta, a U.S. economist at Credit Suisse Securities USA in New York. “Conditions are certainly a lot healthier and seem a lot more normal now.”
One offshoot of the recession -- increased oversight of the consumer-credit industry -- probably means the wage-spending relationship will be strong for years, said Mark Zandi, chief economist at Moody’s Analytics Inc. in West Chester, Pennsylvania.
The establishment of the Consumer Financial Protection Bureau and laws aimed at fostering fairness and transparency, including the Credit CARD Act of 2009 designed to help Americans understand how much they are paying in fees and interest, will probably limit the use of plastic, he said.
“People’s attitudes toward credit are different given what they went through” in the recession, Zandi said.
Consumer spending’s dependence on wages shouldn’t blight the outlook for a pickup in growth, as some earnings measures are accelerating, RBC’s Porcelli said.
The employment cost index has shown a pickup in pay and the National Federation of Independent Business’s survey has reflected an increase in planned compensation. And Porcelli’s preferred wage index -- aggregate weekly payrolls -- climbed 5 percent in the 12 months through December, the best annual showing since 2006 and up from a 4 percent gain in 2013. It rose 5.7 percent a year on average from 2004 through 2007.
Those contrast with the trend in the widely watched average hourly earnings data from the Labor Department’s monthly jobs report, which has been mostly steady. Wages climbed 2 percent in the year ended February, matching the average for the recovery.
Porcelli recently raised his forecast for consumer spending even as readings on retail sales have declined for the past three months. He projects consumption will climb 3 percent in 2015, up from the 2.3 percent he estimated in December. Expenditures rose 2.5 percent in 2014.
The recent wage data “are very supportive of this call,” Porcelli said.