Wages haven't been this crucial to US economy in half a century

WASHINGTON (Bloomberg) - When it comes to U.S. economic growth, wages may never have been this important.

The link between earnings and consumer spending has been tighter in this expansion than in any other since records began in the 1960s, according to calculations by Tom Porcelli, chief U.S. economist at RBC Capital Markets.

Wages have become even more critical as households, still shaken after being caught with too much debt when the recession hit, remain unwilling or unable to tap home equity or let credit-card balances balloon to buy that new television or dishwasher. By not overextending themselves again, Americans are only spending as much as their incomes will allow, meaning that 70 per cent of the economy is riding on how fast pay rises.

"In an environment where credit is not being used in a material way, the fate of wages matters," Porcelli said. "They're doing all of the driving from a consumption perspective."

The correlation between growth in wages and consumer spending adjusted for inflation stands at 0.93 since June 2009, when the recovery began, according to Porcelli. A reading of 1 means they move in the same direction all the time, zero means there is little relationship and minus 1 means they continually diverge.

Porcelli tracked wages through the index of aggregate weekly payrolls for private production workers, which takes into account hourly earnings, the length of the workweek and changes in employment for about 80 per cent of the labor force. Records go back to 1964, longer than the measure for all employees that includes supervisors, which dates back only to 2006.

The outlook for earnings is among the things that will help policy makers decide when to raise interest rates, Federal Reserve Chair Janet Yellen said Wednesday. The labor market has improved enough for central bank officials to prepare to exit the most aggressive easing in the central bank's 100-year history, though too-low inflation and weak pay gains are reasons for caution.

"We will be looking at wage growth," Yellen said during a press conference following the central bank's announcement that it was leaving its benchmark rate near zero. While faster increases in income aren't a precondition for raising rates, "that would be at least a symptom that inflation would likely move up over time," she said.

Fed policy makers reduced their forecasts for how quickly they will raise interest rates this year and next and also lowered the projected rate of economic growth.

One reason why officials will be slow to increase borrowing costs is "the residual effects of the financial crisis, which are likely to continue to constrain spending and credit availability for some time," Yellen said in their press conference.