“Pent up wage deflation” is an unfamiliar and somewhat abstruse term dropped into the economic lexicon last week by Janet Yellen at the annual Jackson Hole conference. Originally coined by researchers at the Federal Reserve Bank of San Francisco, the term is destined to be widely discussed because it is clearly influencing the US Federal Reserve chair’s thinking. If it exists, it would explain why wage inflation seems abnormally low, given the recent rapid drop in unemployment, and that could eliminate one important reason for keeping US interest rates at zero per cent for the “considerable period” promised by the central bank.
Ms Yellen is right to be aware of the concept, and to keep it under review, but in my view the Fed is unlikely to shift in a hawkish direction solely because of it. This blog explains the theoretical and empirical reason why this is the case.
(Warning some of these arguments are quite intricate – skip to the end if you want to avoid the economic debate and just want the policy implication.) Read more