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.
Gross domestic product probably has risen at a 5 percent rate in the current quarter as demand rebounds after a hurricane-induced slowdown last fall. That would be the fastest growth rate in two and a half years.
Many economists expect growth to slow to half that rate or even less later in the year as a five-year-long real estate boom continues to unwind and the Fed's long campaign of raising interest rates begins to pinch.
"I think the Fed should not get too optimistic about economic growth or too scared about inflation," Kelley said. "We have a balanced economy, so a balanced monetary policy is appropriate."
While Kelley thinks the Fed should move to the sidelines now, that seems highly improbable. Wall Street traders and virtually all forecasters expect the Fed to raise short-term rates another quarter-percentage point March 29 at the conclusion of Bernanke's first formal meeting as chairman of the Fed's policy-setting panel.
The move seems even more inevitable after Friday's job report, said Joel Naroff of Naroff Economic Advisors.
"This report says the economy is in good shape," said Naroff. "That is a lot of jobs in February when there was a snowstorm and it was cold."
From the Fed's point of view, the concern is not just that individual wages are rising but that as employers expand their payrolls, productivity growth inevitably is slowing.
"It means the labor costs of production are going up a lot faster than they have in a long time, and businesses have to ask the question, how am I going to sustain my earnings growth?" Naroff said. One obvious possibility: raising prices.
Even if many forecasters are looking for growth to slow later in the year, that is not enough reason for the Fed to hold off, Naroff said.
"The Fed can't simply make an assumption that there is nothing to worry about," he said. "(Bernanke) can't afford to let inflation get out of control in his first year."
If employers continue to add more than 200,000 jobs a month to payrolls, the unemployment rate will head lower and the Fed is more likely to keep raising rates, said Mark Zandi, chief economist for Moody's Economy.com.
But he and others also said the Fed might not have to raise rates much more as general financial market conditions work in its favor to slow the economy. For example mortgage rates have risen to their highest levels in several years, all but ensuring the housing market will continue to cool. The stock market also has been helping the Fed's cause by moving "sideways," although stock prices rose sharply Friday in reaction to the robust employment report.
With the overnight lending rate at 4.5 percent, compared with a 46-year low of 1 percent in mid-2004, Kelley thinks short-term rates are already at neutral, but he acknowledges that the new Fed chairman is under some pressure to raise rates further, if only to prove to Wall Street that he is serious about inflation.
Kelley said more rate hikes will not tip the economy into recession but will simply slow growth at a time when no more increases are needed to accomplish the goal.
"In the end, if he pushes rates too high and has to cut them later he won't have proved anything," Kelley said. "The best way to establish yourself is to do the right thing and ignore people on both sides."