AMERICA’S unemployment rate is 5.5%. By historical standards, that is low. It is also falling rapidly: unemployment is down more than a percentage point from a year ago. Economic theory suggests that in such circumstances, workers should begin to enjoy healthier pay rises. Low unemployment means that employers have to try harder to find new workers, while existing workers can threaten to move elsewhere. As a result, workers should be able to demand higher wages. Yet firms in America seem not to have got the message. Inflation-adjusted wages for typical workers are stagnant. In fact, they have barely grown in the past five years; average hourly earnings rose 2% year-on-year in February of 2015: about the same as in February of 2010. Why hasn't America's falling unemployment translated into faster wage growth? To understand current patterns one first has to remember how American firms behaved during the 2007-09 recession. At that time, they were desperate to cut costs. They would like to have foisted pay cuts on their staff. But cutting pay is harder than it sounds (just imagine what would happen to workplace morale if your boss tried to cut everyone’s pay by 10% overnight). Instead, employers reacted to the deep downturn by firing as many workers as they dared, beginning with the least productive. Better workers, meanwhile, were squeezed in order to boost their productivity, so as to manage too-high wage rates without having to lay off the cream of the payroll. As conditions improved after the recession ended, firms' prior response left them with a wage hangover. Rather than continue to pump workers for extra productivity, firms preferred to return to more normal management conditions, and to let too-high wages adjust over time: “pent-up” wage cuts have been achieved simply by not granting raises. Wages, in other words, are not rising by more because in many cases they are already too high.

Yet there is also evidence that many workers are not demanding high wages. Oddly, that may be down to a reform to America’s unemployment-insurance scheme taken at the end of 2013, which slashed the maximum time for which Americans could draw unemployment benefits. About 1.3m Americans were affected immediately. With nothing to fall back on, the wage expectations for many unemployed people fell. In economic parlance their "reservation wage"—or the threshold pay rate needed to coax them into and keep them in employment—declined precipitously. To take advantage of the growing pool of cheap workers, employers in certain sectors went on a hiring binge. Indeed, a big chunk of the 3m extra jobs created during 2014 were in low-wage sectors.

The biggest reason for sluggish wages, however, remains what it has been for most of recent history: America’s sickly labour market. Unemployment is low, but other measures of labour-market “slack” paint a much bleaker picture. The number of workers who work part-time but would rather be full-time (so-called “part-time for economic reasons”) is still much higher than before the recession hit. This is important: a recent paper from the Federal Reserve Bank of Chicago found that even after accounting for other measures of unemployment, the number of workers counted as “part-time for economic reasons” exerts a very strong effect on wage growth. (That is probably because such workers would rather push their employers for more hours than for higher pay). Policymakers should not be fooled by the unemployment rate. The American labour market is much more robust than it was, but it is a long way from full health. It will take many more months of strong job growth to generate rapid and sustained growth in pay.

Dig deeper:

It will take faster wage growth to sustain a healthy American recovery (April 2015)

Stingier benefits may be helping along rapid American job growth (January 2015)