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The Journal Gazette

Tuesday, November 07, 2017 1:00 am

Fed finds self in good spot

Can stand pat while unemployment, inflation stay low

Matt O'Brien | Washington Post

The Federal Reserve has one of the best problems it could right now: Inflation isn't supposed to be this low when unemployment is also this low.

It's pretty simple. When almost everyone who wants a job has one, companies are forced to compete with one another by offering workers higher pay. Which, if it goes on long enough, will eat into their profits enough that they have to raise prices, too.

Wage inflation, in other words, will eventually turn into price inflation. It's an apparent trade-off between unemployment and inflation that economists call the Phillips curve.

However, that's not happening now. That might just be due to the fact that the labor market isn't nearly as strong as the 4.1 percent unemployment rate would lead you to believe.

The share of 25- to 54-year-olds who should be in the prime of their working years and are also, in fact, working is well below the all-time peak set in 2001, or even the pre-recession one in 2007. It's only about 80 percent of the way back to where it was then.

Which is to say that, even eight years into the recovery, there still appears to be plenty of what's called “shadow slack”: people who want to work, but aren't officially unemployed, since they've given up looking for now.

That, more than anything else, might explain why workers don't seem to have the bargaining power you'd expect with joblessness at its lowest level since Bill Clinton was in the White House.

If this is right, wages just need more time for more people to get back to work. After that, they'll go up.

The thing is, though, it might not even matter if they do. After all, it's been awhile since wage inflation has turned into price inflation the way the Phillips curve tells us it should. Since 1994, wage growth only “explains” about 2 percent of core inflation; between 1965 and 1994, it was 56 percent.

What in the name of Econ 101 is going on?

Well, nobody knows for sure. It might be that companies are more willing to accept lower profit margins when they know for a fact that the alternative is higher interest rates.

But this is almost beside the point right now. The conclusion is the same for the Fed: Don't pull the plug on the recovery by raising rates too soon.

Like I said, it's the best kind of problem. It's solved by doing nothing.