I would not say that wage growth is a litmus test for changes in monetary policy, but it is something that is indicative both of likely inflationary pressure going forward. It's not a sure sign of it, but it's relevant, and it's also relevant in assessing whether or not we are at maximum employment.

Yet the labor market’s journey is not yet complete – more progress needs to be made. My outlook is that as the expansion continues, firms will continue to add to their payrolls and the unemployment rate will continue to decline. I expect that by the end of next year, the unemployment rate will fall to around 5½ percent, which is what I view as the “natural rate,” or longer-run rate, of unemployment.

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Putting all of this together, I expect growth over the next six quarters to be somewhat above my estimate of trend growth, which I put at around 2.5 percent. Of course, there is always a good deal of uncertainty around estimates of trend growth, perhaps even more so today in the aftermath of such a deep recession. I am a bit more optimistic than some about longer-run growth because while productivity growth has been running low, I think it is good to remember the experience of the 1990s. Back then, over a period of several years, many forecasters revised down trend growth estimates only to subsequently revise them up significantly in response to strong productivity growth.

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One might ask whether that’s a reasonable inflation forecast given that we haven’t seen much acceleration in wages yet. I believe it is. Cleveland Fed analysis, based on several measures of wages and broader compensation, indicates that it is difficult to find a lead-lag relationship between wages and prices – the strongest correlations are contemporaneous ones, especially since the mid-1980s. We should expect wages to rise with prices, not necessarily lead prices. In my view, it would not be prudent for policymakers to simply wait for wages to accelerate before assessing the implications of the stance of monetary policy for future price inflation. Indeed, policymakers must always be forward looking.

As I said, employment has been growing at a good clip. In fact, the number of private-sector jobs is back above its pre-recession peak. Overall employment, which includes the public sector, will probably reach its previous peak in another month or so. But thats the number of jobs. In the interim, the population has been growing, bringing more potential workers into the fold. At the same time, the first round of baby boomers is headed into retirement, which means people being taken out of the labor pool.

Its hard to know precisely what the natural rate is, but I put it around 5 to 5 percent. To put things in perspective, the current unemployment rate of 6.3 percent is still well above the natural rate. My forecast is for the unemployment rate to gradually decline over the next two years, reaching the natural rate sometime in 2016.

One indication that unemployment is still higher than its natural rate is that growth in workers pay has been pretty modest. In fact, wage growth has averaged only about 2 percent over the past few years, and there are few signs of any acceleration in wages. That said, I expect that once the unemployment rate gets even closer to its natural rate, wage growth should pick up.

Recent increases in U.S. wages and salaries have been quite modest and do not show evidence of “ratcheting up” related to recent supply shocks (see Figure 7).

I expect wages to rise, and I do think that higher real wages are completely compatible with low inflation.

With respect to wages, there are alternative measures of wages that give somewhat different answers, but I agree that, for example, that average hourly earnings for production workers as measured by the payroll survey has not shown real gains.  And one of the key problems there, it's important to note, is, in fact, the increase in energy prices. So what people get at the pay stub, they lose at the gas pump.

Anecdotal reports suggest that the labor market is tight in some industries and occupations and that employers are having difficulty attracting certain types of skilled workers.  To date, however, moderate growth in most broad measures of nominal labor compensation and the ongoing increases in labor productivity have held down the rise in unit labor costs, reducing pressure on inflation from the cost side.

If we're going to address wages and in particular inequality in wages, we've got to do that, I would say on the supply side; that is, by addressing the skills gaps that exist among different groups of people in our society.

Moreover, increases in compensation costs have generally been modest. To be sure, average hourly earnings of production and nonsupervisory workers have been accelerating in recent quarters. However, the broadest measures of compensation have not picked up, suggesting that competition in labor markets has been intense. Nonetheless, with labor markets tightening, some pickup in compensation increases for the broad measures would not be surprising. Nor would a pickup necessarily be inflationary, given the very good growth in labor productivity that we have experienced in recent years.

The available evidence suggests that the pace of economic expansion may moderate a little from its average over recent quarters, keeping resource utilization in line with recent levels.

Labor costs may increase for firms as the pool of available workers continues to shrink.  Thus far in the current economic expansion, firms have benefited from strong increases in productivity that have allowed them to offer higher wages to workers without affecting their profitability.  But as the labor market has tightened and as productivity growth has slowed, further efforts to expand may result in faster wage growth.

With respect to labor compensation, my sense from the data and our business contacts is that cost pressures remain in check, although recent data also give conflicting signals. One key measure, the Employment Cost Index, has recorded only modest increases over the past year. A second more inclusive measure of compensation shows a more substantial rise....A more rapid rise in compensation per hour could be part of the process by which labor's share of income returns to more normal levels, hence unthreatening from an inflation standpoint. 

We're developing a bivariate labor market...We have an oversupply of high-skill jobs and an undersupply of people to fill them, the effect of which is to create a significant acceleration in average incomes of the highly-skilled segment of our labor force.

Unit labor costs so far have been of less concern than I might have expected a couple of years ago. Productivity gains have certainly helped.

I don't think we should stick our head in the sand and say that we don't have to worry or think about unit labor costs at this point.  It's one of those things we have to continue to watch very carefully and be sure that in addition to the other cost pressures we get, that we don't at some point begin to see labor cost pressures that would add to the inflationary pressures that I talked about.