a wage price spiral It’s an inflationary nightmare. This is a situation in which prices spike, possibly due to sudden shocks, policy failures, or both, and wages rise sharply to keep pace, resulting in more inflation and more wage growth. Fall into a vicious cycle. It may appear as if the global economy is experiencing this devastation. In the United States, hourly wages rose about 6% last year, the largest annual increase in 40 years. In the UK, wages, excluding bonuses, are rising at about 7% a year. On June 14, when the Fed chose to keep rates on hold after 10 straight rate hikes, Chairman Jerome Powell said wage developments were among the test of whether the central bank would resume rate hikes in July. I warned you that I was watching you.
But the dangers that appear in nightmares bear little resemblance to threats worth worrying about in real life. The uncomfortable ride from global inflation over the past two years seems to point to a similar conclusion for the wage-price spiral. The wage-price spiral is a satirical take on what happens to an economy with inflation problems.
A historical analogy often drawn when discussing wage price spirals is the 1970s. As the spiral framework suggests, price and wage inflation seem to have interacted throughout that decade. Every time general price inflation spiked, wage inflation spiked, followed by more price inflation, and so on. In the 1970s, however, the evidence for the existence of spirals is flawed. Repeated waves of inflation were due more to a series of oil price shocks (1973 and 1978) than to previous wage increases. In that wages and prices moved in tandem, this reflected the trade union practice of the time, fixing wages to the cost of living, and guaranteed a ratchet effect. The spiral was a feature of the contract rather than a proof of economic concept.
Late last year, a group of economists IMF We surveyed historical records to create a database of wage-price spirals in developed countries dating back to the 1960s. Applying fairly low standards and examining acceleration in consumer prices and rising nominal wages in at least three of four consecutive quarters, we identified 79 such episodes. But a few quarters of high inflation aren’t all that scary. A few years from now it’s a lot scarier. Judging by this longer criterion, IMF Economists offered a more optimistic conclusion that the “majority” (exact percentage omitted) of the short-term spiral was not followed by a sustained acceleration in wages and prices.
In a March memo, economists at the Fed’s Chicago branch, Gadi Barleby and Luojia Hu, explored the role of wages in the current inflation episode. They focused on “non-housing services”. It’s a category that covers everything from car washes to health checks, and Powell regularly cites it as a useful metric because of its close association with wages. Barleby and Hu concluded that wages help explain this part of inflation. Nominal wage growth has significantly outpaced productivity growth over the past year. When faced with cost pressure, service providers naturally want to raise prices.
But spiral theory argues that not just wages matter, wages predict future inflation trends. In this regard, economists at the Federal Reserve Bank of Chicago found that the relationship is unidirectional. Inflation helps predict changes in labor costs, but changes in labor costs cannot predict inflation. In other words, service providers raised prices before rising wage costs hurt their bottom lines. Barleby and Hu argue that employers may have anticipated the impact of a tight labor market. As such, wages are a lagging rather than a leading indicator of inflation.
San Francisco Fed economist Adam Shapiro is more critical of wage concerns. In a May memo, he addressed the unexpected shift in wages, arguing that rising labor costs were only a small driver of non-housing services inflation and negligible in broader inflation. Like his Chicago colleagues, he concluded that wage increases are following inflation.
This does not mean that the wage-price spiral is a complete myth, as some zealous pundits have written.As IMFA study points out that a serious spiral can occur. It’s just that they are very rare. If inflation remains very high for an extended period of time, people may begin to regard rapid price increases as a fundamental fact of life and incorporate that assumption into their wage demands. This process may have started in the UK.
What is striking in the US over the past two years, however, is that inflation expectations have remained relatively modest despite price pressures. In a paper for the Brookings Institution think tank last month, former Fed Chairman Ben Bernanke and former Fed chief economist Olivier Blanchard said: IMF, decomposed the factors of pandemic-era inflation. They conclude that most inflation overshoots since 2020 have been caused by a series of shocks (surge in commodity prices, strong demand for goods, and supply shortages). Evidence that inflation itself caused wage demand to rise is scant. Wages soared simply because demand for workers exceeded supply.
Wages and prices can rise by the same force. So to the excess spending in the economy is the shortage of both products and the workers to produce them. Whether or not prices and wages interact, overheating the economy is worth worrying about.
Meanwhile, Bernanke and Blanchard argue that an overheated labor market is likely to contribute more to inflation as the shock of the pandemic wears off. To prevent this, central bankers need to ensure that demand for workers cools down. Only if inflation persists after the labor market has rebalanced should we fear an autonomous spiral. ■
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https://www.economist.com/finance-and-economics/2023/06/15/wage-price-spirals-are-far-scarier-in-theory-than-in-practice The wage-price spiral is far scarier in theory than in practice