Why economists aren’t so worried about a wage-price spiral anymore


Employees prepare orders at ‘Wok to Walk’ restaurant in London’s Soho district, UK, Friday, September 30, 2022. UK retailers are facing a mortgage ticking time bomb, rising interest rates expected to have a double impact on consumer finances like the recent spike in utility bills, according to a Deutsche Bank analyst. Photographer: Jose Sarmento Matos/Bloomberg via Getty Images

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For workers struggling with the skyrocketing cost of living, the idea that rising wages are a concern has always seemed laughable. But they worried some policymakers and economists last year.

Minutes of the March 2022 meeting of the US Federal Reserve felt uncomfortable that “substantial” wage increases would fuel higher prices.

In the UK, the discussion was even more candid, with Treasury officials publicly saying there was an inflationary risk from workers who expect wages to follow rising prices. The Governor of the Bank of England, Andrew Bailey, even went so far as to call for “restriction in wage negotiations” (and the German finance minister made a similar plea).

Experts worried about a so-called wage-price spiral. This happens when workers expect inflation to keep rising, so they demand – and get – higher wages to keep up with rising prices. Firms then raise the prices of goods and services to cover higher labor costs, at the same time that workers have more disposable income to increase demand. This creates an inflationary loop, or in the language of economists, “second-round effects”.

This is claimed to have happened in the 1970s when inflation hit 23% in the UK and 14% in the US in 1980.

But although the concerns this time around are not totally gonewhat is most frequently talked about now is that a wage-price spiral did not occur in the roughly 18 months when inflation peaked in much of the world.

The European Central Bank’s March minutes, released on Thursday, say wages have “had only a limited influence on inflation over the past two years”. Treasury Secretary Janet Yellen also said she does not see a wage-price spiral in the United States

And during the spring session of the International Monetary Fund, the group’s chief economist, Pierre-Olivier Gourinchas, told CNBC that it was not something he was worried about regarding the outlook for economic growth. world.

“What we’ve seen in the last year is that prices are going up very quickly, but wages haven’t gone up that much, and that’s why we have a cost of living crisis,” Gourinchas said. , after noting that core inflation remained high in many countries. and in some cases increased.

“We should expect wages to eventually catch up and people’s real income to pick up,” he said. Real income refers to wages adjusted for inflation, reflecting changes in purchasing power.

But the increase does not pose a risk because “the corporate sector has been sitting on quite comfortable margins,” Gourinchas continued. Business revenues “have grown faster than costs, so margins have room to absorb rising labor costs.”

The ECB’s March minutes say their analysis revealed “the increase in [corporate] profits had been significantly more dynamic than wages.”

Profit-price spiral

There has also been growing discussion about how these corporate profits are contributing to inflation.

In a recent note, ING’s economists focused on Germany, where inflation is increasingly a problem on the demand side. While warning that the so-called ‘greed’ cannot be proven and that there are variations by sector, they wrote that there are signs that companies have raised prices before their costs have risen. inputs, and that “from the second half of 2021, a significant part of the price increase can be explained by the rise in corporate profits.” They call it a profit-price spiral.

The President of the Central Bank of the Netherlands, Klaas Knot, in December urged companies to raise wages for workers and said wage increases of 5-7% in sectors that could afford them, combined with government support on the energy bill, would help balance the effects of inflation rather than to feed it.

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Kristin Makszin, assistant professor of political economy at Leiden University, agrees. She told CNBC that while wages and prices are rising, we can’t ignore the external factors driving up wages (including the tight labor market) and prices (like supply shortages).

“Since the global financial crisis, wages have not recovered,” she said. In the United States, for example, an annual wage increase of about 3.5% would be considered positive, representing inflation of 2% and productivity growth of 1.5%, but it has late on thisMakszine said.

“It’s not that a wage-price spiral can’t happen, but it’s low on the list of concerns compared to factors we know are problematic,” she said. These include a potential downward spiral of low wages and productivity – when wages are not sufficient to reintegrate people into the labor market or into areas where they are needed, holding back productivity and therefore Economic Growth.

A key mechanism that would fuel a wage-price spiral, workers’ bargaining power, has been weakened because unions have less power than they did in the 1970s, Makszin added.

But with a tight labor market, people may simply refuse to work — and that’s an area policymakers need to address, she said. “In sectors like hospitality in the United States, wages have risen dramatically, but this corrected several decades of poorly paid work when the workforce was replaceable…this could be seen as compensating for the stagnation long-term wages,” she continued.

Risk of stagflation

According to Alberto Gallo, chief investment officer at Andromeda Capital Management, the country that is “the most vulnerable developed market economy” when it comes to the price-wage spiral is the United Kingdom.

Figures released this week showed UK wage growth slowed less than expected in the three months to March 2023, rising by 6.9% in the private sector and 5.3% in the public sector. Meanwhile, inflation remains above 10%, ahead of 7.8% in Germany and 5.3% in the United States.

The risk, Gallo said, comes from a mix of structural factors that contribute to stagflation. As low- and middle-income households grapple with soaring prices for food and other basics and higher rates erode people’s purchasing power in a heavily indebted housing market, the central bank actually keeps real rates – inflation-adjusted interest rates – at the most negative level in developed markets.

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Meanwhile, the pound is weak – and 50% of the country’s goods are imported – and foreign labor has been restricted by Brexit.

“We are emerging from a period where real wages have been stagnant for a long time and high inflation is finally pushing workers into strong renegotiations,” Gallo said. “But if you let interest rates fall against inflation and actually weaken, you have an inflationary spiral. Basic goods [inflation] has gone down, but basic services are not going down,” Gallo said.

Not the 1970s

Richard Portes, professor of economics at London Business School, told CNBC there was “no serious risk” of a wage-price spiral in the UK, US or major European countries. He also cited the reduction of union power in the private sector as a notable change from the 1970s.

“If you look at underlying inflation in the United States, rents, housing, have been driving this. It has nothing to do with wages – with rents, it’s more sensitive interest rate hikes,” he added.

There is evidence – including IMF — that wage-price spirals are not common. IMF research has found very few examples in advanced economies since the 1960s of “sustained acceleration” in wages and prices, both stabilizing instead, keeping real wage growth “broadly unchanged”. Like so much else in economics, the idea that wage-price spirals even exist has also been challenged.

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For Kamil Kovar, economist at Moody’s Analytics, the scenario has always been perceived as a risk, not necessarily probable. But he too said that over time it has become clear that this is not happening.

Wages are likely to rise quite rapidly for Europe, but there are ‘so many possibilities for wages to catch up with prices, to get to a spiraling situation we would need something totally different to happen’ , did he declare. The ECB expects real wage growth of around 5% this year.

Real wages in Europe are so much lower that before the pandemic, they could rise another 10% without entering a “danger zone,” Kovar said; while in the United States they are about equal but outside the risk zone.

Comparing the current situation to the 1970s, Kovar said there were some similarities such as an energy shock; at the time it was in oil, whereas this time it is bigger and broader, also impacting electricity and gas. The fall in energy prices also accelerated as this shock subsided.

And again, he noted the continued growth of corporate profits and the absence of strong unions as additional factors as to why this time is different.

“It’s an example of how we are slaves to our historical parallels,” he said. “We are potentially overreacting even if the underlying situation is different.”

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