Will the Fed move too far on interest rates?

Martin Wolk Chief economics correspondent • Profile • E-mail

Friday's strong employment report keeps the pressure on new Federal Reserve chief Ben Bernanke to raise short-term interest rates but also heightens the risk that central bankers will slam too hard on the economy's brakes.

That at least is the view of David Kelley, senior economic adviser for mutual fund giant Putnam Investments, who believes the Fed should hold rates just where they are — an outcome considered extremely unlikely by most forecasters.

The February employment report showed the economy added 243,000 jobs in February, more than generally expected and the best result since November. In addition, hourly earnings now are rising at a 3.5 percent annual rate, the fastest pace in nearly five years, raising the prospect of wage-led inflation that the Fed is determined to keep under control.

But Kelley points out that even at 3.5 percent wages are not quite keeping up with inflation, continuing a trend that has been evident since the economy began adding jobs in August 2003.

"I think we're in the early innings of any wage inflation pressure," Kelley said. In a normal expansion, wages are supposed to rise more than inflation, reflecting growing productivity that allows Americans to enjoy a rising standard of living.

But since mid-2003, even as the unemployment rate has fallen to the current 4.8 percent from a peak of 6.3 percent, wages for production and non-supervisory workers in the private sector have risen only about 7 percent, while consumer prices have risen about 8 percent.

Meanwhile total personal income has risen nearly 13 percent, accounting for executive salaries, earnings of self-employed people and non-wage income like rent and stock dividends.

Or to put it more bluntly: "It's clear that people in the lower parts of the income distribution are not doing as well as people at the top," Kelley said.

That could be one reason why the general public does not express a lot of confidence in the economic expansion, which is now more than four years old.

Kelley points out that consumer sentiment, at least as measured in a closely watched survey done by the University of Michigan , is well below its average over the past decade, after falling rather sharply in February. In addition, a separate survey from the Conference Board shows that more people describe jobs as hard-to-get today than in September 2001, when the unemployment rate was higher than today and rising.

That glum view is also reflected in a survey published Friday, which showed that only 40 percent of Americans approve of the way President Bush is handling the economy, compared with 47 percent a year ago.

Kelley also points out that employment growth is a lagging indicator, so February's growth largely reflects hiring businesses have done in response to strong economic growth in December and January that is almost certain to slow in the months ahead.

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