The Fed's Problem With the Job Market

Federal Reserve officials worry that rising wages will lock the economy into a high-inflation regime. The question facing policy makers is how much of a risk of that happening there actually is.

Fed policy makers seem all but certain to raise their target range on overnight rates by three-quarters of a percentage point when they meet this week, but the focus has already moved to what they will do next. On the one hand, inflation is still running hot, with the Fed’s preferred measure of inflation showing consumer prices were 6.2% higher than a year earlier as of September. It isn’t as bad as the 7% logged in July, but it hasn’t eased as quickly as either the Fed or private economists expected. So maybe the Fed should keep pumping the brakes.

On the other hand, the central bank has already lifted rates mightily in a short period—on Wednesday the midpoint of its target range will presumably be 3.875%, compared with 0.125% as recently as March. Considering that the full force of rate increases work on the economy with a lag, as well as an accumulation of anecdotal reports that some prices are cooling, the Fed might want to slow the pace of its rate increases. Fed Chairman

Jerome Powell

might signal that the question of whether the central bank should raise rates by another three-quarters of a point at its December meeting, or a smaller half point, is a matter of debate.

Much of that debate, and the one over how far the Fed should ultimately raise rates, hinges on the degree to which the tight labor market is feeding into inflation. There is no question that the job market is tight: Economists polled by The Wall Street Journal think Friday’s jobs report will show the unemployment rate was 3.6% in October, slightly above September’s 3.5% but still extremely low. Moreover, they think that average hourly earnings will be up 0.3% in October from September, which implies a gain of 4.7% from a year earlier.

Then again, the unemployment rate was 3.5% in January 2020, before the economy was experiencing any pandemic effects. Back then, though, average hourly earnings were up 3% on the year, and inflation was running short of the 2% the Fed was aiming for. So something has changed.


What impact do you think rising wages will have on inflation? Join the conversation below.

One difference might be that despite the similar-looking unemployment rates, the job market is effectively much tighter now. The number of unfilled job openings has lately started to fall a bit, but it is still far higher than before the pandemic. The share of workers quitting, which some people view as a better measure of labor market tightness, is also higher than before the pandemic, but it has been falling since the end of last year—one indication, argues economist

Justin Bloesch

in a recent Roosevelt Institute post, that the current low level of unemployment rate isn’t inherently more inflationary than prior to the pandemic.

Separately, a recent Evercore ISI analysis suggests that the increase in wages is more of a lagged response to the rise in inflation than inflationary in itself. Wages aren’t rising because people are trying to get ahead of future inflation so much as they are trying to catch up with costs that have already risen. Some supporting evidence for that: On Friday, the Labor Department reported that its employment-cost index, a measure of worker wages and benefits, rose 5% in the third quarter from a year earlier. That is a big jump but still less than inflation.

The problem with all this for the Fed is that it is easier to sit back and argue that the labor market might not be generating all that much inflation when there isn’t much inflation. It might well be that the rise in prices has more to do with factors such as pandemic-related distortions and Russia’s invasion of Ukraine than anything else, but the proof of that won’t come until inflation cools. The best outcome would be for it to emerge before the Fed breaks the job market.

Write to Justin Lahart at

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