Kink in the Curve

America’s current economic expansion, which started in June 2009, has been perplexing.  Our nation’s expansion has been described by some as a “New Normal” after old economic relationships have proven less reliable than before.  For instance, our economy’s pace of growth since the end of the Great Recession has been sluggish even though the Federal Reserve began expanding the nation’s monetary base in an extraordinary manner starting in October 2008.  With their printer running full throttle, the central bank expected the additional money supply would help create incentives for business investment.  Unfortunately, this has been something very slow to materialize.  And capital investments have not been the only aggregate statistic to lag in this business cycle. 

Another economic relationship which seems to have broken down during this post-financial crisis period pertains to the labor market and price levels.  During other economic cycles, there was a more pronounced inverse relationship between the unemployment rate and inflation (i.e. falling unemployment was accompanied by periods of accelerating upward price pressures).  This relationship is demonstrated by the Philips Curve, named after William Philips.  Wage growth is one of the primary drivers of inflation, yet despite low unemployment levels, it has remain rather flat.  Economists from the San Francisco Branch of the Federal Reserve have looked into this phenomenon and came up with a plausible partial explanation: demographics.

These researchers dissected wage growth and created two categories of earners.  The first group is comprised of those workers who were employed full-time continuously.  The second group contains those who are new or returning to full-time work; this group is more likely to earn below average wages, thus suppressing the total growth.  Additionally, as baby boomers exit the first category, the statistic loses workers whose pay was near their lifetime peak.  Further compounding the issue, new and returning full-time workers (whose pay tends to be below average) are replacing the highly-paid older generation. 

Since the baby boomers will continue to retire in the years ahead, this period of low aggregate wage growth could continue, even as America’s employment situation remains virtuous.  William Philips is one of the most talked about economists these days.  Even casual readers of economic news are likely to have run across Philips’ idea.  Baby boomers seem to be putting a kink in his curve, and time might be the only remedy to normalize reality into a shape which once again fits his theory.