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Why Hit the Brakes Now?—Viewpoints | EPI

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Why Hit the Brakes Now? 

By Jared Bernstein

Now that the economy is finally helping working families get ahead, it’s too bad the Fed decided to hit the brakes. The Fed’s decision to raise interest rates by one-quarter point won’t end the boom, but it will unnecessarily slow things down.

The rate hike was unwarranted for two reasons. First, while the Fed’s rationale for the increase was the tight labor market and the potential for “wage-push” inflation, there is no evidence to support this fear in the near term. Second, even the most hawkish inflation fighters are not worried about the current rate of price growth; Wednesday’s rate hike was preemptive. While such advance strikes may have been called for in the past, the current economy absorbs Fed actions quickly enough that preemption is no longer necessary.

Yes, real wages are rising, but so is productivity, a measure of economic efficiency. In fact, as Chairman Greenspan has acknowledged, the acceleration in productivity growth has been more than enough to cover recent wage increases. What about future wage increases? On that score, productivity continues to accelerate and wage growth, while still positive, has actually slowed in recent months. There is simply no convincing evidence of wage inflation in the current labor market.

Broad-based wage gains have been long awaited. Through most of this recovery (and through most of the 1980s as well), the real wages of low- and middle-wage workers fell sharply; it wasn’t until unemployment began to tumble around 1996 that wage trends reversed course. And the benefits of the tight labor market do not stop with wage increases but include historically large employment gains for minorities, flush public coffers, and even lower crime rates.

If unacceptably large price increases loom down the road, the Fed can step in and deal with them at that time. One of the salutary effects of the central bank’s increased openness in recent years is that key sectors of the economy, such as financial and housing markets, absorb rate increases almost instantaneously, obviating preemptive strikes. The precious gains of full employment should not be even partially sacrificed because of the phantom menace of future inflation.


Jared Bernstein is an economist at the Economic Policy Institute. He specializes in labor markets and wage inequality and is a co-author of State of Working America 1998-99.

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