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Why those pay hikes are not going very far

Wages are up from a year ago. Inflation is creeping up, too.

By Staff writer of The Christian Science Monitor / June 2, 2006


As a restaurant manager at Zeppe's Pizzeria, Kym Costello says she's earning good money selling pizzas, subs, and some of the best French fries on the east side of Cleveland.

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As a college student who drives 35 miles to class each day, she's also spending a lot - and she reckons her income is not keeping pace with the rising costs of living.

It's a common quandary in today's economy.

On average, American paychecks are rising, as employers offer higher salaries to attract and retain staff. At the same time, inflation has been heating up, burning a bigger hole in consumers' pockets.

The result is a dynamic that's challenging for workers and potentially risky for the economy.

Some analysts say now is the time for workers to enjoy an overdue improvement in their living standards. But others fear a wage-price spiral, in which pay raises ripple into the costs of goods and services, making no one better off.

"Wages are accelerating. I think that's a good thing," says Ken Mayland, president of ClearView Economics in Pepper Pike, Ohio. "But what the [Federal Reserve] will worry about is that these wage increases will just get caught up in more price increases."

That hasn't happened yet. But once a spiral starts, it can be hard to stop, experts say. Concern has risen in recent weeks. Two gauges of inflation have edged up beyond the Federal Reserve's comfort zone - with higher than 2 percent annual growth in "core" prices, which exclude food and energy.

Meanwhile, wages seem to be picking up, although a report Thursday suggested some softening of the trend. The Department of Labor said hourly compensation - which includes benefits as well as wages - rose at a 5.3 percent pace in the first three months of the year, but fell at a 0.9 percent annual pace in the final quarter of 2005.

The Labor Department's April jobs report, released a month ago, showed the sharpest rise in average hourly earnings during the current economic expansion: a 3.8 percent jump from the same month a year earlier.

Fed policymakers will be watching the May jobs report, due out Friday, for further signals on whether they need to boost short-term interest rates for the 17th time when they meet June 28 and 29. A weaker-than-expected number on job creation, for example, could temper worries that a tight labor market is fueling inflation.

"The Fed has a lot of credibility as an inflation fighter now," says Dr. Mayland. "But if it does anything to reduce that credibility, then the economy would pay the price of that for a long time."

Long-term interest rates, for example, could rise as investors demand a premium to cover expectations of higher future inflation.

Still, it isn't necessarily inflationary when wages rise faster than prices. Rising "real" (inflation-adjusted) wages are the norm in a healthy economy.

Employers typically cover the cost of pay raises by improving productivity. A reduction in corporate profits, now at record levels, is another way to pay for wage hikes. It's when pay raises lead to price hikes, and then to expectations of further gains in wages and prices, that a spiral gets going. Some current straws in the wind suggest that the risk is real enough:

• An April survey of small businesses found that more are raising prices - and about the same number say they are hiking wages.