A phenomenon is defying economic theory and disrupting the Fed’s debates on monetary policy: why is wage growth slowing even though the labor market is so tight?

The US unemployment rate has dropped to its lowest level in over half a century, but wage increases have slowed. The Fed’s preferred measure of labor spending, the Employment Cost Index, has shown three consecutive quarters of small increases. A narrower measure – the average hourly wage of employees – has also slowed, with an annual gain of 4.4% in January, compared to 5.9% last March.

The answer will go a long way in determining whether the Fed can reduce inflation without hurting employment and the economy as much. If the pressure on wages continues to ease even as employers keep hiring, policymakers may feel less compelled to extend the rate hike. As supply chain problems abate, Jerome Powell has focused on the labor market as a major source of inflationary risk.

Two theories conflicted. According to some analysts, what drove the excessive wage increases seen a year ago was an inflationary surge resulting from the pandemic, exacerbated by Russia’s invasion of Ukraine. Workers reacted to the rise in gas and other essential goods prices by pushing for higher wages. Now that price gains have eased from the peak, demand for more significant wage gains should also reduce.

Other economists have a more pessimistic view. Labor costs may have decreased as the reopening-fueled hiring boom has waned. But the labor market remains out of balance, with demand for labor still far outstripping supply. This will keep wage increases and inflation at a high level.

It is hard to conclude at this stage, and we remain dependent on future economic data. Jerome Powell will have the chance to present his vision this week with the semi-annual testimony on the economy to Congress.