Even after watching it play out, and to somewhat disastrous effect in the inflation data, macro observers seem reluctant to countenance the reality of wage-price spiral dynamics.
Note that because this is a chicken-egg problem, flipping it around to call it a price-wage spiral (in an effort to vilify corporate management teams) doesn’t solve the underlying dilemma, even if it’s a politically useful distinction.
Like everything else since 2020, the situation is exacerbated meaningfully by lingering pandemic distortions. Yes, the pandemic set the stage, but three years later, the legacy of societal shifts and policy choices engendered by the virus continue to perpetuate the play.
This is particularly vexing in services-based economies. As I put it in the latest weekly+, “Last week’s barista raise is next week’s latte inflation which is next month’s barista raise.” When it comes to problem-solving, it doesn’t so much matter if you insert “latte inflation” at the beginning of that chain. One way or another, the cycle needs to be broken. It’s not always obvious that determining “which came first” is helpful in that regard.
That said, Goldman’s Joseph Briggs and Devesh Kodnani suggested, in a new note, that wage growth in the current cycle has been “disproportionately” driven by inflation, which in turn suggests an end to the spiral assuming price growth moderates. They quantified it. Price increases, they wrote, “have been three to four times more important than [labor market] slack in explaining wage growth.”
Of course, this is all self-reinforcing, something Goldman underscored using the figure below, which they described in maddeningly (if unavoidably) circular terms. “The impact of inflation on wage growth is higher when the labor market is very tight, and the impact of a tight labor market is higher when inflation is very high,” Briggs and Kodnani said.
They suggested that when the mismatch between worker demand and supply peaked in the US last year, the incremental impact of higher inflation on pay growth might’ve been double the effect one would expect in a balanced labor market. Ultimately, though, they said labor market tightness is “more an aggravating factor than a principal driver,” or at least in the US.
Goldman did endeavor to solve the chicken-egg dilemma as part of their analysis. Using correlations “at various time differentials,” the bank determined that “changes in sequential headline inflation tend to lead — rather than lag — changes in sequential wage growth.”
So, if inflation is indeed playing a bigger part in pushing up wages during the post-pandemic cycle, then a material moderation in inflation could presage a commensurately significant drop in wage growth. To a point.
The bad news is that much as economists worry about a “now comes the hard part” dynamic with inflation (whereby cajoling price growth the rest of the way back to 2% from, say, 4%, will be much more difficult than the initial goods- and base effects-driven disinflation which brought price growth down from 40-year-highs), the home stretch for wage growth will likewise be arduous irrespective of what happens with CPI itself.
The figures above show that during the acceleration phase, inflation plays a bigger role, while slack contributes evenly on the way down.
As Briggs and Kodnani put it, summarizing, “the wage inflation and disinflation process may be asymmetric — much like the business cycle itself — with an increase in labor market slack usually being required to fully return wage growth to target-consistent levels despite the earlier disproportionate contribution of headline inflation to wage dynamics.”
So much analysis, so many vague and uncertain conclusions… I think Whire Rabbit is on the turntable, and the needle just keeps skipping!
After reading this I happened upon a Bloomberg story which may seem unrelated but may not be. As you concede, the word order is relevant in a political context. Focusing interest rate policies solely on reducing wage growth will likely fuel yet more resentment from the 70%. Sadly, in the US that manifests in growing support for extreme right-wing ideas and, as we saw in Texas this past weekend, violence.
‘We Just Want Someone Sane’: What Happens When a Small Town Goes MAGA https://www.bloomberg.com/opinion/features/2023-05-07/gop-election-deniers-are-gunning-big-for-pennsylvania-local-government
How do restrictive Fed policies help bring down prices of the daily staples relevant to most Americans? Will they bring down food and healthcare prices? The last time the latter fell was in 2009 when demand fell thanks to layoffs which left many Americans without insurance coverage. I guess a similar mechanism may help reduce demand for some food items, but otherwise?
Some help if Fed actions reduce diesel prices, theoretically reducing distribution costs. Theoretically because fuel or energy cost surcharges are as sticky as wages are said to be so it will be months until they are rescinded, if at all.
So that leaves housing and autos which certainly are showing the impact of higher interest rates. Is that popular on Main Street? Or to folks who work in construction?
It could be that the Fed is forced to back off or even reverse course if the commercial real estate market weakens further. A witty populist, like Ronnie-D, might ask why the Fed only responds when the business sector is damaged by their policies…
Yes, “the Fed has to do something”, but that “something” may be helping the nation step over the edge.
Would the Fed ever dare to comment on how corporations raising prices well beyond the increase in their costs is forcing them to keep rates higher for longer? Nah.
One factor that I hadn’t considered previously when considering housing construction was that new construction might hold up better than I previously anticipated due to the lack of existing homes for sale. I’m hoping that helps ameliorate some of the longer term housing inflation. All bets are off though if interest rates come tumbling down again at some point.
I think new SFR construction will hold up, the builders have figured out how to make a normal-ish profit (GM% and OM% generally at or above pre-pandemic levels) and they have customers in both owner-occupant and institutional rental fleets. However, new multi-family dwelling projects are almost non-existent, and new office as well. When existing MFD and office projects are done, I’d think construction jobs will get thinner.
https://www.aia.org/pages/6617159-abi-march-2023-business-conditions-improve
Interesting reading
Yeah, the order of the words may not matter to a looped phenomenon but it does matter where you break that loop. Is it going to be at the wage stage, screwing up workers as always or are we for once going to squeeze corporations?
The Fed isn’t the best tool for the job. The Federal government is. But it’s so mired in stasis we may only have the Fed available and the only thing they can do to break the loop is break the economy in its entirety via a recession… while hoping for a soft landing.
But if, as Derek suggests, they were at least as willing to speak about greedflation as they are to mention wage price spirals, I think it’d be a good first baby step.
A GIANT thumbs up, sir.