We have to restore price stability. We really do, because everything—it’s the bedrock of the economy. If you don’t have price stability, the economy’s really not going to work the way it’s supposed to. It won’t work for people—their wages will be eaten up. So we want to get the job done. This inflation happened relatively recently. We don’t think that it’s affecting expectations in any kind of fundamental way. We don’t think that we’re seeing a wage–price spiral. We think that the public generally sees us as very likely to be successful in getting inflation down to 2 percent, and that’s critical. It’s absolutely key to the whole thing that we sustain that confidence. So that’s how we’re thinking about it.

— Fed Chair Jerome Powell, June 15, 2022

With compensation costs typically accounting for around 70% of total production costs, wages are a key driver of aggregate price increases—if wages increase, prices are likely to follow. Similarly, if prices increase, wages too are likely to follow. While the magnitude of that correlation can and has varied significantly over the years and depends on many factors, such as the tightness of the labor market, labor bargaining power, etc., the reality is that wages play a strong role in the inflationary environment. Hence for the Fed, the behavior of wages is a key deciding factor with regard to its outlook for inflation and monetary policy. In this Economics Weekly, we examine the current wage dynamics and what the Fed will be looking at as it heads into next week’s FOMC meeting.

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Richard de Chazal, CFA, is a London-based macroeconomist covering the U.S. economy and financial markets.