Will big U.S. job gains raise inflation risks?

“There's no real pressure on unemployment,” said Challenger. “I suppose if you're worried about inflation, it's not great news.”

The reason for the inflation worry is that with unemployment at historical lows, some employers may have hard time filling jobs, which spurs them to raise salaries. If employers with growing businesses find jobs hard to fill, they're also under pressure to hand out raises to keep good workers from leaving.

All if which is great for workers. But if wages start to rise too rapidly, the risk is that the higher cost of labor – along with the extra money in consumers pocketbooks - could add upward pressure to prices. The question many analysts are now asking: how low can the unemployment rate go before the tight labor market begins to spark inflation?

Economists talk about the “natural” rate of unemployment; a level low enough to keep wages growing and consumers spending, but not so low that a tight labor market raises labor costs and begins pushing prices higher. Most experts generally peg that “natural rate” at 5 percent; the last time the jobless rate rose above that level, in 2001, wages gains soon began declining. Shortly after the jobless rate fell back below 5 percent in 2005, wage growth picked up again.

But there’s a debate underway in economic circles about whether ongoing changes in the economy could bring that “natural rate” lower — without sparking inflation. A number of cross-currents are at work. After rapid gains in productivity of the American workforce during the 1990s, for example, a slowdown in those gains could raise labor cost pressure. On the other hand, globalization and the outsourcing of production to cheaper labor markets continue to cut labor costs for some employers.

The question is more than academic. Since the destructive runaway inflation of the 1970s, Fed policy makers have considered inflation to be Public Enemy Number One. Given a choice between cutting interest rates to stimulate the economy and raising them to fight inflation, the modern Fed has tended toward a clear bias against inflation. With energy and food prices already on the rise, tight labor markets have become one more inflation worry to keep Fed official up at night.

Just as the job market has become more global, so too has the fight against inflation. Over the past 12 months, the Fed has held fast to its “do-no-harm” policy of leaving short-term rates alone, based on its reading of the U.S. economic data. So far, the strategy seems to be working well. Though the latest data on U.S. employment have been strong, they don't appear to pose an immediate inflation threat.

Meanwhile, with the global economy booming, other central banks around the world, particularly in Europe, have been busy raising rates based on the inflation threat they see in their own countries.

Those countries’ rate moves are one reason that long-term rates — including the mortgage rates you pay in the U.S. — have moved higher in recent weeks, according to David Wyss, chief economist with Standard & Poor’s.

“Bond markets have become global,” he said. “And what's going on in Europe may have more impact on our bond yields than what the Fed does.”

MORE FROM EYE ON THE ECONOMY

Eye on the Economy Section Front

Fed, in shift, floods system with cash Deflation poses new economic threat Bush speech sets tone for summit Worsening slide challenges Obama  Obama to make early mark on economy Economic downturn picking up speed Downturn squeezes state budgets Fed rate cut might have little impact High price may thwart tax cut plans U.S. confronts possibility of deep recession Eye on the Economy Section Front   Add Eye on the Economy headlines to your news reader: