Janet Yellen may be poised to rewrite Fed's rule book on wages, inflation

Jun 25 2014, 11:05 IST
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SummaryFederal Reserve Chair Janet Yellen wants to see U.S. wages climb at a much brisker clip to boost consumer spending

Federal Reserve Chair Janet Yellen wants to see U.S. wages climb at a much brisker clip to boost consumer spending and help workers recoup ground they lost in the last recession, but she'll have to fend off policymakers who fear that could cause inflation to surge.

As she seeks to maintain a consensus at the central bank, Yellen will have strong arguments in favor of nursing the recovery for longer and should be able to counter any calls for an early interest rate hike.

Research from the Fed's staff and her own past academic work both suggest there may be more slack in the economy than inflation hawks believe, and that businesses in recent years have been slower to raise prices than they were previously.

If that is the case, then interest rates could remain lower for longer and inflation allowed to push beyond the Fed's 2 percent target without fear of it losing control. It's a policy Yellen has indicated she is willing to pursue to encourage wage growth and bring as many workers as possible back into the full-time labor market.

The connection between faster wage gains and a healthy jobs market is emerging as a core principle for the new Fed chief, who has said she expects pay to accelerate to something close to the long-run growth rate of 3 percent to 4 percent a year from the current level of around 2 percent.

"My own expectation is that, as the labor market begins to tighten, we will see wage growth pick up some to the point where ... nominal wages are rising more rapidly than inflation, so households are getting a real increase in their take home pay," she said last week, adding: "If we were to fail to see that, frankly, I would worry about downside risk to consumer spending."

Yellen has balanced her concerns over a weak labor market and slow wage growth with a commitment to price stability in the long run. And for now, she contends, there is no tension between the two because there is so much slack in the economy.

The debate, however, may well test the limits of the Fed's tolerance for inflation. For some policymakers, that limit is already close.

In comments on Tuesday, Philadelphia Federal Reserve Bank President Charles Plosser said Fed policy had already become "too passive," and the central bank needed to better explain why another year of near zero interest rates

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