Economics

Global economy supplement: wage growth will improve

An interview with the newest regional Federal Reserve President Loretta Mester

November 10, 2014
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"I think that again we, like the United Kingdom, have seen very slow wage growth, so far,” says Loretta Mester, President and Chief Executive Officer of the Federal Reserve Bank of Cleveland. “But again as the economy picks up some momentum and unemployment continues to fall and firms continue to hire, I expect wage growth to pick up.” Loretta Mester took charge of the Cleveland Fed in June. She is also a voting member of the Federal Open Market Committee—the body chaired by Janet Yellen, the Chairman of the Federal Reserve Bank—which sets US interest rates.

Mester spoke exclusively to Prospect on a wide range of subjects, including the concept of secular stagnation. This theory was first posited by the economist Alvin Hansen in 1938 and recently resurrected by Lawrence Summers, the former United States Treasury Secretary. The theory states that economies can experience long periods of weak demand, which cannot be overcome even by near-zero interest rates.

“I am probably a little bit more optimistic about the US economy, I think fundamentals are very good here,” says Mester. “We have made a lot of progress. I am not as negative as some on longer-term growth. I am still thinking that there will be around 2.5 per cent—I admit that this is a little bit slower than I would have had before the financial crisis.”

Mester says that “there has been some decline,” in economic growth for the US and other developed economies, “but that reflects things like demographics.” In her remarks she also addressed the connection between technological innovation and growth, which some experts, most notably Professor Robert Gordon of Northwestern, have suggested is ruptured.

“I am more positive on innovation,” says Mester. “I think that some people are saying that innovation—we have basically gotten all we can out of tech innovation—and I don’t buy that. I think we have more to do there and I am more positive.”

According to the International Monetary Fund, the US will experience Gross Domestic Product growth of 2.8 per cent in 2014—UK GDP growth is expected to be 3.1 per cent. But just as significant as the economic growth itself is what happens to wages.

“Research has shown that wage growth picks up with inflation, it doesn’t necessarily lead inflation,” she says. “I am expecting as growth picks up here we are going to see some acceleration in wage growth,” though as David Hale points out (see p7), there is disagreement at the Fed centre on how to interpret wage and employment data.

It is an analysis that would please the UK  government. The opposition has attacked the government’s economic record on precisely this point, maintaining that there is a “cost of living crisis”—that the economy is fundamentally broken, no longer capable of passing on the benefits of economic growth to the broader population. Mester disagrees.

Before wages can rise, productivity must increase: output per employee must rise. The current consensus is that productivity growth is weak, but Mester challenges this. “I take lessons from the 1990s,” she says, “when many economists were concerned about the low productivity growth.” However, she says, “those numbers got revised up and productivity growth ended up being stronger than it was anticipated to be.”

“If you look at the innovation that’s going on in the economy, I think that productivity growth is going to pick back up. I am not extrapolating out the weak productivity growth that we have seen.”

For that reason, Mester says that, “the US economy is probably on firmer footing than it’s been in some time,” citing the declining unemployment rate, improving business and consumer sentiment and stimulative policies from the Federal Reserve. She also adds that because of declining spending by the US government, “fiscal policy is less of a drag—and no drag this year—probably and turning to a bit of a positive next year.” She also expects inflation to rise gradually, held down by recent declines in oil prices.

However, she also notes that there are “still a significant number of long-term unemployed,” in the US. Could this be in part due to the effects of the continued slump in the eurozone?

“Certainly export growth will be affected and we have a stronger dollar and that affects our economy,” says Mester, who forecasts growth in the US next year of 3 per cent. This level, she says, takes account of “some of the drag, if you will, from Europe on the export side.”