The Fed’s narrow view of inflation threatens to snatch defeat from the jaws of

By Brian Bethune

Longer-term perspective on monetary policy would boost U.S. growth and innovation, and strengthen national security

The COVID pandemic business cycle was unprecedented across multiple dimensions: A major public health threat on a scale not seen for a century; complex demand and supply shocks; the Ukraine war, and structural shifts in the employment markets.

Remarkably, the U.S. economy rebounded with vigor, supported not only by monetary and fiscal policies, but also a broad range of innovations, including large-scale temporary furloughs, voluntary “work-from-home” arrangements and a coronavirus vaccine.

Yet after demonstrating on-the-fly innovations, productivity and growth, the U.S. is at a crucial turning point where the Federal Reserve’s monetary policy could impair key drivers of the supply side of the economy and snatch defeat from the jaws of victory.

The pandemic economic gears did not mesh perfectly. Supply chain pressures increased significantly in several rounds and peaked at the frontiers of abnormality in December 2021: a negative “Black Swan” event.

Amazingly, these pressures reversed and re-normalized between February 2023 and September 2023. Intermediate processed goods prices also saw acute upward pressure not seen for decades beginning in January 2021, continuing through 2022, as the Ukraine war reverberated through commodity markets. But these pressures also re-normalized in the second- and third quarters of 2023.

The unequivocal good news is that the bulk of these shocks are now behind us, but certain myths and fallacies need to be addressed to get clear on the future potential of the U.S. economy.

Wage inflation is a myth

The popular “wage inflation” mantra is a myth. The share of wage compensation in overall business income declined to 56% in 2019 from 66% in 1960, and during the pandemic cycle the share declined further to 55%. If there were true “wage inflation” the exact opposite would have happened.

Business prices “per unit of output” jumped by an average annual rate of just under 6% during the pressurized period from the end of 2019 to the middle of 2022. Profit per unit accounted for the largest share, about 47% of the price increase. Employment costs accounted for about 40% of the price increase, and other costs 13%. The average annual increase in employment costs during this period was just over 4%, compared to the increase in profits of 22%.

Employment costs were temporarily boosted to a higher level by the recall to work of relatively low-wage leisure and hospitality, and retail trade employees. This reflected a significant increase in the risk and complexity of these occupations. Personal risk, including risk of serious personal injury, infection, illness or even mortality, is a key compensation variable, albeit hard to calibrate, that is consistently left out of employment studies.

By contrast, there was…