Fear of a 1970s-style wage-price spiral is being used by central banks to stiffen monetary policy - but by slowing economies now they may just exaggerate an overarching long-term ill of falling real incomes.
For decades, policymakers used anxiety about wage growth chasing inflation higher, thereby pushing up prices further in a self-reinforcing loop, as reason to pre-emptively slow economic activity and quickly snuff out periodic pops in inflation.
Amid wild economic swings around the pandemic, the U.S. Federal Reserve - which only recently changed tactics to acknowledge it may have been overhasty in past tightening - decided to look through bounce-back inflation for a period. Now it is scrambling to catch up as inflation rates have failed to subside and jitters about matching wage rises resurface.
Minutes of the Federal Reserve Open Market Committee’s March meeting released this week showed that policymakers see “substantial” wage increases fueling higher prices, and are concerned that wage pressures are spreading and will remain “elevated.”
The overwhelming consensus on Wall Street is the Fed must - and will - raise interest rates aggressively. Some indicators, like 3.6% unemployment and the high ratio of jobs to job seekers, support Fed Chair Jerome Powell’s assertion that the labor market is “extremely tight” and potentially inflationary.
But many influential economists think stabilizing real wages solely by weakening the economy will only exaggerate the problem.
Real earnings growth is negative. The latest rates of annual consumer price inflation and nominal wage growth are 7.9% and 5.8%, respectively, although inflation should ease back later this year.
In real terms, average weekly earnings in February were where they were in 1974, and were lower than the same month last year, according to Bureau of Labor Statistics data.
Robert Reich, professor at the University of California, Berkeley, and a former Labor secretary in the Clinton administration, argues it is “misleading” to suggest the labor market is tight.
“There’s no wage-price inflation. With all due respect, I don’t know what world he (Powell) is inhabiting,” Reich told Reuters, adding: “Anybody who believes that firms cannot afford to pay more to their workers without raising prices cannot do basic math.”
Reich notes that corporate profits are the highest since the 1950s, firms are passing on higher costs to customers, and share buybacks are at record levels. If the labor market really was tight, much more of that flow would surely go to workers.
Despite the recent high-profile cases of worker mobilization at Amazon.com Inc and Starbucks Corp, the fact remains that barely 6% of U.S. private-sector workers are in a trade union. That is down from 25% in the 1970s and 20% in the early 1980s.
At an aggregate level, collective bargaining power has never been weaker.
Employers are not manning the barricades just yet.
A survey published in February by Payscale, an online salary, benefits and compensation information company, showed that 44% of firms expected to award pay rises of more than 3% this year.
That is higher than previous years but annual consumer price inflation at the time of the survey was 7% and is now almost 8%. Significantly, the share of firms expecting to award pay rises of 5% or more was lower than in 2016, 2017, and 2021.
A survey of 1,004 U.S. companies by Willis Towers Watson in January showed that firms anticipated average pay growth of 3.4% this year. Again, that is up from recent years but still well below inflation.
It is difficult to see these pay rises being revised higher with the Fed poised to tighten monetary policy at the fastest pace since 1994, which will slow the economy, perhaps into recession.
David Blanchflower, economics professor at Dartmouth College and former Bank of England policymaker, says raising rates in this environment is a mistake and will “kill off” the first signs of nominal wage growth after decades of declining real wages.
“Is this demand-pull inflation? No. This is not inflation being pushed by wage growth. There is no evidence that companies are raising prices because of increases in wages,” he said.
This is crucial for markets. Steve Major, global head of rates strategy at HSBC, is well below the Wall Street consensus in his U.S. rates and bond yields outlook. One thing that will change his “lower for longer” view is sustained wage growth.
Joseph Briggs, an economist at Goldman Sachs, wrote this week that a “substantial” economic slowdown is needed to reduce wage growth to an “acceptable pace” of 4%-4.5%, a level consistent with the Fed’s inflation forecasts of around 2%-2.5% for 2023 and 2024.
But that would require an another 75 basis points of monetary tightening not yet priced in to markets, he estimates, which would raise the risk of a hard landing for the economy.
If Reich and Blanchflower are right, increasing the chance of recession will not put upward pressure on wages.
Be smart with your money. Get the latest investing insights delivered right to your inbox three times a week, with the Globe Investor newsletter. Sign up today.