Everyone who's remotely concerned with economics is fretting about when the Fed will hike interest rates — not "whether," but "when." Federal Reserve Chair Janet Yellen recently hinted that "when" could be "soon," jolting markets. All of this is a bit surreal.
The Fed's job is, on the whole, pretty simple: Try to keep a balance in the economy between employment and inflation. If the economy is overheating, if there's more money to go around than there are goods and services to be bought, that will show up as increased prices — a.k.a. inflation. If the economy is below capacity, there will be stagnation and no inflation. Well, where are we? Inflation in the U.S. is at an all-time low. And while unemployment is low, so is growth, and the drop in unemployment has as much to do with people dropping out of the workforce as with economy recovery. There's simply too many unemployed people to raise rates yet.
But there's a second, more overlooked reason that the Fed shouldn't raise rates: wage stagnation. Have you noticed that median wages have basically remained the same for 40 years? A lot of economists are concerned about that, especially when you factor in the number who are anxious about income inequality.
Why is it that wages should have stayed flat all those decades? Here's a hint: It's like someone with the power to wreck the economy has been saying for 30 years, "If wages rise, I'll wreck the economy." Here's another hint: That "someone" is the Fed.
The Federal Reserve is very good at fighting inflation — but another word for "inflation" is "rising wages." That's what happens when you have inflation — prices rise across the economy, including the price of labor.
Here's how it works: During an economic recovery, demand for stuff increases, pushing its price up. Employees see the price of stuff go up, and so they demand higher wages as a result — and because the economy is improving, demand for labor is rising, and so their request is granted. This can set off a vicious cycle in the economy: If workers demand and get raises each time prices rise, this can set off a chain where the price of stuff causes the price of labor to rise, causing the price of stuff to rise, and so on, generalizing inflation. This is what caused the atrocious "stagflation" of the 1970s, and this is the demon that the Fed has been fighting ever since the early '80s.
It's a legitimate fear, but the Fed has gone too far to the other extreme. Over every economic cycle, the Fed has raised interest rates well before we got to the "wages go up" part of the cycle I described above, even as inflation and real growth kept getting lower. Prolonged, sustained, high inflation is very destructive to the economy, but sometimes an economy that does well will produce short bursts of inflation. That's fine, and quashing them only quashes growth and the wage increases that come with them. Today we freak out if inflation looks like it might hit 2 percent, but during the Reagan presidency, inflation was closer to 5 percent and we remember those years as "Morning in America."
A policy targeting a certain level of nominal GDP growth, which Yellen has dismissed in the past, would occasionally produce bursts of moderate inflation, but would have produced a much stronger recovery, and could very well deliver significantly better real wage growth over the long run. But the Fed, obviously, doesn't intend to try it.
Neither Janet Yellen, nor Ben Bernanke, nor Alan Greenspan have ever sat in a dark room cackling about making everyday Americans worse off. We live in a world of very difficult tradeoffs. A world with stronger middle class wages and moderate inflation would be better in many ways but also, undoubtedly, worse in ways we can't predict.
But no matter how unintentional, the Fed's policy for the past 30 years has been to boost the economy during a recession enough to alleviate unemployment and growth (and fatten corporate America's coffers) — but squelch the economy the minute it looks like that boost to the economy might translate into real wage growth. The wage stagnation problem probably has other causes, but this part of it certainly hasn't helped — and it is certainly a problem.