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Fed's Sober Reality -- It's Not Just Jobs, But Wages

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Fed Sober Reality -- It's Not Just Jobs, But Wages: John Berry

March 17 (Bloomberg) -- While Federal Reserve Chairman Alan Greenspan has been optimistically predicting a surge in new hiring, the Fed statement issued after yesterday's Federal Open Market Committee reflected a more sober reality.

Fed officials are concerned that the continued lack of job growth could sap the strength of the now solid U.S. economic expansion.

Recent employment reports were so weak the committee changed the mildly optimistic language in its January statement, which read: ``Although new hiring remains subdued, other indicators suggest an improvement in the labor market.''

Instead, yesterday's statement said simply: ``Although job losses have slowed, new hiring has lagged.''

Obviously, with increasing worry about jobs and the durability of the expansion on the table, any serious discussion of when the FOMC might want to raise its 1 percent target for overnight interest rates has been pushed well into the future.

The terrorist attack in Madrid, which may make many investors more wary about taking on new risks, undoubtedly heightened concerns about the economic outlook.

Not From Wages

New hiring, and the income that goes with it, is essential to allow consumers to continue to increase their spending when stimulus from the 2003 personal income tax cuts wanes later this year. Those tax cuts, and those that preceded them in 2001 and 2002, have been responsible for most of the gains in households' after-tax incomes that have powered the expansion.

The truth is, over the past three years, inflation-adjusted wages and salaries haven't gone up at all.

According to the government's Bureau of Economic Analysis, the wage and salary component of U.S. personal income rose 4.6 percent, slightly less than the 4.8 percent increase in the price index for personal consumption over the period.

So where is the income growth needed to support increased consumption going to come from?

Probably not from big wage increases. Average hourly earnings rose only 1.7 percent in the 12 months ended in February. A broader measure, the wage and salary portion of the Bureau of Labor Statistics' employment cost index, increased 2.9 percent last year, enough to keep workers a bit ahead of inflation, though not by much.

Refunds Spent

Charles L. Schultze, former chairman of President Carter's Council of Economic Advisers, is among those who share the Fed officials' worry. Part of the problem, he stresses, is not just the lack of jobs but the fact that labor hasn't shared in the overall rise in national income generated by the recovery from the 2001 recession.

``Much of the increase in output has come from productivity gains. While real wages have increased slightly, only a small part of the recent growth in national income has gone to workers,'' Schultze, now senior fellow emeritus at the Brookings Institution, said in an interview. ``A disproportionate amount has gone to profits.''

The boom in profits is helping investment, which is boosting the economy, ``but we still need healthy consumption growth,'' Schultze said.

`Surprisingly Weak'

``Over the last three years, consumption has kept growing nicely despite the lack of real income gains because of tax cuts and mortgage refinancings, some of whose proceeds were spent on consumer goods,'' he continued. ``But once this spring's tax refunds have been paid, the tax cut string will have run out. And cashing out home equity through refinancings can't by itself support the needed growth in consumption.

``So the economy ultimately is going to need a big improvement in job growth, not just for the jobs themselves, but for the added income needed to keep the recovery going,'' Schultze said.

The Fed officials' concern about hiring was signaled in the central bank's semi-annual monetary policy report sent to Congress in February. At the FOMC meeting in late January, the policy makers found lots of reasons to be optimistic about the economic outlook. ``However, some risks remained in light of continued lackluster hiring evidenced by the surprisingly weak December payroll employment report,'' the report said.

Since then two more months' worth of ``surprisingly weak'' employment reports have been issued, adding evidence that this economic expansion is fundamentally different from those of the past. Productivity gains have been so strong as to be all but unbelievable.

More Productivity?

Greenspan could be right when he argues that companies may be running out of unexploited ways to increase productivity accumulated during the 1990s. On the other hand, given the incredible competition many companies face -- competition that has kept them from systematically raising the prices of the goods and services they sell -- he could also be wrong.

The economy isn't going to fall out of bed in the second half of this year. It has too much momentum.

Economic growth might simply slow down, which would further limit new hiring. A few forecasters, such as those at Goldman Sachs, already show such a deceleration to a 3 percent annual rate. Moreover, that prediction assumes a resumption of payroll job growth on the order of 100,000 a month by this summer.

``However, if employment growth continues to disappoint, the second-half growth outlook would darken and a further fundamental'' decline in Treasury yields ``would become likely,'' Goldman told its clients this week.

Wrong Outcome

That sort of outcome is not one the Fed would like to see, to put it mildly. Still, there's not much policy makers can do at this point to affect what happens during the next few months.

Some people who have observed Greenspan closely for a long time, including some former Fed officials, have been struck by how determinedly optimistic he has been in his testimony and speeches so far this year.

He has downplayed all the things that could go wrong, one former official said. Perhaps the Fed chairman doesn't want to undermine anyone's confidence that everything will go right.

A few months of strong job growth would give everyone's confidence a boost, including all those on the FOMC.

To contact the writer of this column:

John M. Berry in Washington at [email protected].

To contact the editor of this column:

Joe Winski at [email protected]

Last Updated: March 17, 2004 00:07 EST


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