New York (MainStreet) - Amid all the talk of flat wages blighting the American worker, the untold story of the day is really inflation.

While America debates the state of its economy and its workers' real earning potential, what matters most is the opinion of one entity: the Federal Reserve.  Though the economic gatekeeper has maintained interest rates at or near 0% throughout the recession and recovery, it may have signaled a return to higher rates later this year. This would indicate confidence that the recovery is for real and an intention to return focus to matters of inflation.

Unfortunately, for most Americans this recovery is anything but real, as a detailed report released yesterday by the Economic Policy Institute shows. Tinkering with interest rates prematurely could spell hardship for the common American on Main Street by pushing prices higher without much of an uptick in wages.

Brass Tacks  

First, a quick (and basic) primer on the link between interest rates and unemployment.

The Federal Reserve fluctuates interest rates to “speed up” or “slow down” the economy. Lower rates make loans cheaper, which encourages borrowing; this pushes more money out into the marketplace through lending and spending. When the system works, this increased spending drives down unemployment by creating demand for goods, services and the workers who supply them. Lower unemployment eventually leads to better wages since everything, even labor, becomes more valuable when it’s scarce.

Too much wage growth risks inflation. If pay grows faster than productivity, prices go up, since consumers will have more purchasing power relative to the supply of products. This creates a wage-price spiral: higher wages push prices higher, which in turn pushes wages higher and so on. The Federal Reserve works to strike a balance between encouraging robust employment while not letting inflation get out of hand. A little inflation, in fact, can be helpful to consumers struggling with debt.

In response to the Great Recession, the Federal Reserve cut interest rates, eventually all the way down toward zero. That worked up to a point. Although top line unemployment figures have fallen, the critical upward pressure on wages is missing. It’s been missing for a long time.

In fact Americans haven’t gotten a raise in 35 years, and it’s been particularly bad over the last seven.

Where We Are Now 

EPI study author Elise Gould writes that “[c]omparing 2014 with 2007 (the last period of reasonable labor market health before the Great Recession), hourly wages have been flat or falling. And ever since 1979, the vast majority of American workers have seen their hourly wages stagnate or decline. This despite real GDP growth of 149% and net productivity growth of 64% over this period.”

Although we have the strongest labor market since 2007, Gould argues that it can’t yet absorb anywhere near the number of people who got sidelined during the recession. With these millions out there, the unemployed, underemployed and simply not counted, there’s no pressure for employers to compete.

Gould also takes aim at the idea of wage growth as a function of education.

“According to this explanation,” she writes, “because there is a shortage of skilled college-educated workers, the wage gap between workers with and without a college degree is widening. This is sometimes referred to as a ‘skill-biased technological change’ explanation of wage inequality.”

As intuitively appealing as it is, this explanation doesn’t seem to work. Wages have fallen not along educational lines but across them. Those with college and advanced degrees are losing ground alongside everyone else. The well-educated actually suffered the most between 2013 and 2014, with holders of advanced degrees losing the most earning power of any educational group. (The well-educated have, it should be noted, done better overall. Only holders of advanced degrees have not lost earning power overall since 2007.)

What of the two groups whose wages have grown, the wealthy and the poor? The aggregation of wealth at the top is no surprise; that’s where all gains in productivity have gone. But Gould notes that there’s an explanation for improvements at the bottom as well: minimum wage laws.

“[An] economically significant increase occurred at the 10th percentile, up 11 cents, or 1.3%," Gould writes. "This can be attributed to a series of state-level minimum-wage increases, which have been proven to lift wages, particularly at the bottom of the wage distribution.”

To eliminate doubt, Gould compared increases in the 18 states that recently raised their minimum wage laws against those that did not. States with an increase grew their 10th percentile wages by 1.6%. The rest grew an anemic 0.3%.

No invisible hand automatically improved the pay and quality of life for those at the bottom. It took specific government action that appears, currently, to have succeeded.

Onward? Looming Interest Rates

What’s the takeaway from all of this? First and foremost, that the job market is in far worse shape than its stewards seem to believe. The idea of a high-performing “knowledge economy” is popular, but seemingly inaccurate in the face of falling wages for all. More importantly, the growth that should accompany a normal employment rebound just isn’t happening.

A healthy recovery, with workers taking back good jobs, should push wages up. Yet employers continue to pay as little or less than before, and the absence of pressure to increase compensation indicates a gaping blind spot in our employment numbers. Regardless of the data, many Americans are still desperate enough to take whatever they can get. The market remains flooded with labor, and that makes us cheap.

In the long run, this also reveals something structurally disturbing about our economy. A healthy marketplace shouldn't force people into a slow crawl to the bottom, and others have written about the corresponding collapse in union membership as wage growth has come to a halt. Although the nation has gotten richer as a whole by vast amounts, almost nobody has actually shared in that great wealth.

Right now, though, we need to worry about interest rates. A Federal Reserve that overreacts to employment numbers could slow down economic growth to prevent a feared wage-price spiral. The only problem is, the wages simply aren’t there to drive it. Pulling cash out of the economy could reduce demand long before workers could financially survive it.

“The stagnation of hourly wages is the most important economic issue facing most American families,” Gould writes, “and most of our key economic challenges hinge on whether or not hourly wages for the vast majority grow.”

Americans haven’t gotten a raise in 35 years and that’s a story. Today, though, the story is inflation.

--Written by Eric Reed for MainStreet