Yellen Wage Signals Showing Slack May Be Missing Cost Speedup

Federal Reserve Chair Janet Yellen says wage gains remain slow and that’s a sign there’s plenty of slack in the labor market. Some Wall Street economists disagree.

Yellen has cited three gauges showing hourly earnings, employment costs and compensation in arguing that salary increases are muted. Yet economists including Torsten Slok of Deutsche Bank AG say other data are better indicators of where pay is headed: higher.

“The trend is certainly not the Fed’s friend,” said Slok, Deutsche’s chief international economist in New York. He cited a speed-up in pay of production workers, which rose to a year-on-year rate of 2.3 percent in April from 1.3 percent in October 2012.

Faster growth of labor compensation would have big economic implications and play into the debate over how fast the economy will grow and whether the Fed needs to keep stimulating it. It would boost household spending, which accounts for about 70 percent of gross domestic product. Since compensation represents about two-thirds of company costs, it would also put upward pressure on inflation and make it harder for the Fed to keep interest rates near zero.

“We’re starting to see some wage inflation,” M. Keith Waddell, president of Menlo Park, California-based staffing company Robert Half International Inc., told analysts on April 23. “We saw rising pay rates for our temporary staff.”

Dean Maki, chief U.S. economist at Barclays Plc in New York, forecast that core inflation will rise above 2 percent by the middle of 2015 as pay picks up. Core prices, which exclude volatile food and energy costs, rose 1.2 percent in March from a year earlier, according to the personal consumption expenditures price index. The Fed’s target for overall inflation is 2 percent.

Nod to Critics

Yellen made a nod in her critics’ direction last week by tacitly acknowledging that some indicators of wages have turned up, without changing her basic message.

“Most measures of labor compensation have been rising slowly -- another signal that a substantial amount of slack remains in the labor market,” she told Congress’s Joint Economic Committee on May 7.

Yellen, 67, is turning to wage statistics to help gauge labor-market tautness partly because of the murky signals stemming from the unemployment rate. Joblessness fell to 6.3 percent in April from a 26-year high of 10 percent in October 2009. Some of that, though, was driven by a fall in labor-force participation, to 62.8 percent from 65 percent.

“As the economy recovers, we might see labor-force participation strengthen, rather than continue to decline,” Yellen said.

Maximum Employment

At the May 7 hearing, she didn’t specify what constitutes maximum employment, saying she wasn’t going “to put a percentage point” on that. In a March 31 speech on the job market, though, she did say that she and most of her Fed colleagues estimated that “maximum sustainable employment is now between 5.2 and 5.6 percent.”

Former Bank of England policy makers David Blanchflower and Adam Posen urged the Fed in a paper last month to focus on labor compensation to determine the health of the job market, given the uncertainties surrounding the unemployment measure.

“If you start to approach full employment, you’ll see it in wages,” said Blanchflower, now a professor of economics at Dartmouth College in Hanover, New Hampshire. Posen is now president of the Peterson Institute of International Economics in Washington.

Yellen told reporters on March 19 that wage gains of 3 to 4 percent “would be normal” given labor productivity. None of the three main indicators she cited in her March 31 speech shows advances anywhere near that.

Broadest Measure

The broadest measure is compensation per hour for non-farm workers. It includes wages, bonuses and benefits as well as an estimate of the earnings of the self-employed.

That gauge rose at a year-on-year rate of 2.3 percent in the first quarter, according to the Labor Department. While that’s faster than the 1.6 percent average gain over the four quarters of last year, it is slower than advances of 2.6 percent in 2012 and 2.5 percent in 2011.

Compensation growth was depressed last year as companies brought forward the payment of bonuses, dividends and other income into the fourth quarter of 2012 in order to beat tax increases on the wealthy starting in 2013.

The employment cost index, another gauge watched by Yellen, has long been a favorite of central bank officials. “When I was in the Fed during the ’90s, it was viewed as the more reliable measure,” said Joseph Ritter, who was an economist at the St. Louis Fed and is now an associate professor at the University of Minnesota in St. Paul.

Truer Picture

The index tracks changes in compensation for specific occupations, such as electricians employed by car companies. The aim is to provide a truer picture of wage pressures by measuring the cost of labor to companies independent of shifts by workers among occupations.

The index shows no sign of accelerating. It rose 1.8 percent in the first quarter from a year earlier, in line with the 1.9 percent average in the previous two years and below the 3.5 percent average increase in the last expansion, from November 2001 to December 2007.

The third indicator flagged by Yellen was average hourly earnings for private-sector employees. Introduced in 2007 and available monthly from the Labor Department, it adjusts the pay of salaried workers to estimate how much they’re making per hour. It doesn’t include benefits.

As Yellen has argued, it too implies that wage gains are muted. Earnings on this basis rose 1.9 percent in April from a year earlier, slower than the 2.1 percent average for 2013.

Signs of Change

Slok said he agreed that there is no broad-based wage pressure now. What worries him are signs that’s changing.

“In the game of Whac-a-Mole, if more and more moles are sticking their heads up, when do I start to believe that things are looking tighter in the labor market?” he asked.

Average hourly earnings for production and non-supervisory employees have risen steadily for the past 1-1/2 years. So far in 2014, the monthly year-on-year increase has averaged 2.3 percent. That’s up from 2 percent last year and 1.5 percent in 2012. In the last expansion it was 3.1 percent.

Maki said he favors this earnings measure over the one covering all employees because it doesn’t include what he views as questionable adjustments to the pay of salaried workers. It also covers more than 80 percent of employees, he added.

History also shows that it is the first to signal a change in the trend of compensation, Slok said.

“The only question is how many months or quarters does it take for the others to follow,” he said.

Small Employers

National Federation of Independent Business data also point to stepped-up wage increases, according to Drew Matus, deputy chief U.S. economist at UBS Securities LLC in New York. The federation’s March survey found small businesses raising compensation outnumbered those reducing it by the most since 2008.

Ellen Zentner, a senior economist at Morgan Stanley in New York, agreed there were signs of bigger wage increases “on the horizon.” Yet she doesn’t see that as a cause for worry.

“Whether the pickup in wage growth comes in the second half of this year or it comes at the beginning of next year, we’ve got a long way to go where it would look like an inflationary risk,” she said.

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