A measure of wages and benefits that Federal Reserve officials have been watching closely as they try to gauge the heat of the labor market grew at a moderate pace over the summer.
The employment cost index, a quarterly measure of inflation from the Labor Department that tracks changes in wages and benefits, rose 1.1 percent in the third quarter of 2023 compared to the previous three months. That was slightly faster than the 1 percent expected by economists and an increase from the previous 1 percent reading.
This pace of growth actually represents a slowdown from a series of rapid quarterly gains in 2022. And on an annual basis, wage gains continue to slow: The labor cost measure rose 4.3 percent on an annual basis, compared to 4.5 percent in the previous report.
Still, the index recorded an average annual gain of 2.2 percent in the decade before the pandemic, underscoring that the pace remains unusually fast today. And it’s notable that wage growth continues to be strong even though economists had expected a return to a more normal pace. The trend could pose a challenge for Federal Reserve officials.
Rapid wage increases are good news for households, but can cause problems for Fed policymakers. Central bankers often worry that it will be difficult to fully contain inflation if wage increases rise quickly. Companies that pay their workers higher wages will likely try to charge more to cover their costs.
Fed officials are meeting this week to discuss what to do next with interest rates and are widely expected to keep borrowing costs stable at the conclusion of their two-day meeting on Wednesday. Economists did not expect that to change after Tuesday’s payroll data.
“It’s more about waiting for the labor market to continue to normalize,” said Oscar Muñoz, chief U.S. macro strategist at TD Securities. “It will take longer, but I think the Fed can be patient.”
To curb inflation, Fed officials have already raised interest rates to 5.25 to 5.5 percent from near zero in March 2022.
These higher interest rates make it more expensive to borrow money to buy a home, a car or expand a business. As companies hire less voraciously and demand weakens, wage growth is likely to slow and companies will find it harder to raise prices without losing customers. This chain reaction is expected to bring inflation under control.
But the slowdown in the labor market was unexpectedly bumpy. Employment gains have slowed somewhat, but they remain much faster than many economists expected after so much Fed action.
That has led Fed officials to keep a close eye on wages.
If wage growth continues to calm even as companies continue to hire robustly, it suggests that continued employment gains are due to improving candidate supply – and that the labor market is still slowly rebalancing.
The logic is simple: If the job market were hot, companies would pay more and more as they tried to poach needed employees from each other. As a result, salary increases would continue to rise rapidly. As the situation cools to a more normal level of tension, economists would expect wage increases to slow.
So far, policymakers have interpreted the labor market data in such a way that balance is actually being restored. That’s partly because another closely watched measure of wage growth, the average hourly earnings index, is showing a steady decline.
This gauge is useful because it comes out every month, but it is also prone to data errors. It tends to change as the composition of the workforce changes. For example, if many low-wage workers find jobs, the hourly wage measure may fall.
With this in mind, Fed officials are closely monitoring the employment cost index, which avoids some of the data errors that occur with other wage metrics.
“Wage growth is slowing, but not as much as other data sources suggest,” Cory Stahle, an economist at Indeed Hiring Lab, wrote in an analysis following the report. He added: “Wage growth is likely to slow further going forward, but the labor market continues to show remarkable resilience.”