With the release of the May Employment Situation Report, we learned that the U-3 unemployment rate fell to a 16-year low of 4.3%. We also learned that there was no wage growth. Average hourly earnings were up 2.5% year-over-year, unchanged from the 12-month period ending in April.
This lack of wage growth has been perplexing against the backdrop of a labor market that some economists say is running at full employment.
Tight labor markets and rising wage growth are supposed to go hand-in-hand as competition for labor intensifies. Since the end of the Great Recession in June 2009, however, there hasn't been much hand holding.
Wage growth has been pretty elusive and it certainly hasn't lived up to the economic standard expected of it given the sharp drop in the unemployment rate in the interim.
We touched on the lack of wage growth acting as a headwind for the U.S. economy in a column in early May entitled, Why U.S. Economy Isn't Earning Its Keep.
Today, we'll look a little further at the lack of wage growth and discuss some other theories for why consumer inflation in general has remained subdued despite the Fed's massive expansion of its balance sheet since the start of the financial crisis. Fittingly, the lack of wage growth is one of the theories.
We are not the only ones scratching their head about why inflation hasn't accelerated much. Fed Governor Lael Brainard made a similar mention in a recent speech, saying the following:
"Today, there is little indication of an outbreak of inflation -- rather, the latest data on inflation have been lower than expected. If anything, the puzzle today is why inflation appears to be slowing at a time when most forecasters place the economy at or near full employment."
Let's see if we can piece together some of the puzzle.
Looking at the lack of wage growth, we theorize that the following factors have helped keep a lid on wage growth:
- Employees remain reluctant to press wage demands, fearful that they will be replaced and will find it difficult to get another job.
- With advancements in technology, the rising cost of health care, and relatively poor job training, the competition among low-skilled and medium-skilled workers to hold onto their jobs has intensified
- Many of the new jobs added during the recovery have been lower-paying jobs
- The percentage of the employed who are members of unions has declined, lessening the influence of union wage demands
- There is more slack in the labor market than what is represented in the U-3 unemployment rate. The U-6 unemployment rate, which also accounts for discouraged workers and those working part-time for economic reasons, is much higher.
The PCE Picture
There are other working theories undoubtedly as to why wage growth has not accelerated. Whatever the case may be, the lack of wage growth is likely helping to keep a lid on consumer inflation in general.
Simply put, if wage growth isn't accelerating, consumers will be more reluctant to spend on discretionary goods and services and they will be increasingly embracing the substitution effect for consumer staples, whereby they look for similar products at lower prices (think generic vs. branded).
That substitution effect is accounted for in the PCE Price Index, whereas it is not in the Consumer Price Index. That consideration is an important reason why the Federal Reserve ("Fed") uses the PCE Price Index as its primary inflation gauge.
The Fed's longer-run inflation target is 2.0%, and, as the chart below shows, the PCE Price Index and the Core PCE Price Index, which excludes food and energy, are both running below that longer-run target.
The PCE Price Index has picked up in recent years, but if we open up the chart to a 20-year period, one will see that PCE price inflation is running at basically the same pace today (1.7% year-over-year) as it was 20 years ago. The year-over-year pace of core PCE price inflation (1.5%), meanwhile, is below where it was 20 years ago (2.0%) and where it was when the Fed launched its massive quantitative easing ("QE") program in November 2008 (1.7%).
It's a stunning consideration really knowing that the Fed's balance sheet has expanded from less than $1.0 trillion in 2008 to $4.5 trillion today.
There were many assertions (and fears) when the Fed embarked on its QE program that it would lead to sharply higher inflation rates. It might still, but clearly it hasn't to this point.
Softness in aggregate demand and relatively sluggish lending activity have tempered the rate at which money is turning over in the U.S. economy. That turnover factor is captured in the St. Louis Federal Reserve's Velocity of M2 Money Stock Ratio, which is calculated as the ratio of quarterly nominal GDP to the quarterly average of M2 money stock (M2 includes the money supply of currency in circulation plus savings deposits, CDs, and money market funds).
Money is of course still changing hands on a regular basis and growth in the economy is still happening, albeit at a modest rate. We know for a fact that is happening with the release of the Retail Sales and Personal Spending reports each month, and it's plainly evident when Walmart (WMT) and Amazon (AMZN) report their quarterly results.
Those two companies in particular have done their share to help keep consumer prices down. It may perhaps be no coincidence that the year-over-year pace of core-PCE price inflation today is lower than it was 20 years ago when, coincidentally, Amazon went public and the popular usage of the Internet was just beginning.
Those two factors we think go hand-in-hand as price suppressants, because they have given the consumer price-comparison power like never before. That is, there is a huge price-shopping advantage at the click of a mouse that just wasn't available more than 20 years ago.
The competition for market share is fierce and that can be seen in the pricing transparency of the Internet, which seems rooted around the approach that any competitor's price will be beat or matched. To be sure, the consumer often benefits from a company trying to gain/retain market share from a competitor with a lower price promotion.
Just look at what's going on these days between Verizon Wireless (VZ) and T-Mobile (TMUS) as a prime example, but let's further the point.
I can see on Orbitz.com that I can get a nonstop, round trip flight between Chicago and Houston, departing October 1 and returning October 8, for $246.40 on American or $388.40 on United at similar times. I can see on Walmart.com that I can buy an 81 count Tide PODS Laundry Detergent Pacs, Original Scent, for $19.97, versus $20.24 on Amazon.
These types of examples can go on and on, whether you're talking cruises, massages, concert tickets, lawn mowers, refrigerators and so forth. The price transparency of the Internet in our humble opinion is not to be underestimated as an inflation suppressant.
What It All Means
The U.S. economy is a huge puzzle. Sometimes the pieces fit together nicely and sometimes they don't.
This is a period when economists are finding it challenging to make the inflation piece fit. Inflation should presumably be running higher than it is given how low the unemployment rate is and how much the Fed has expanded its balance sheet.
Consumer inflation, though, remains in check, which looks to be a supportive piece of the economic puzzle right now since wage growth has been dormant.