Although Wages May Not Be the Cause of Inflation, They are the Target of the Solution.

Jerome Powell, the head of the Federal Reserve, gave a press conference in Washington on March 22, 2023. (Photo credit: T.J. Kirkpatrick/The New York Times)

When the hold of COVID-19 on the economy in the United States started to ease up about two years ago, companies were in a rush to find new employees. This caused the average worker's wage to rise. Unfortunately, this marked the end of one difficulty, but at the same time, there was a chance for another problem to arise.

A lot of financial experts were worried about a spiral of wages and prices, which could happen if companies decided to raise prices to offset the increased labor costs, causing workers to then demand higher wages to keep up with the resulting inflation that would decrease their purchasing power.

In recent times, wages and prices have increased significantly, but the situation is not balanced. According to J.P. Morgan economists, inflation has been growing at a faster pace than wages for 22 months in a row.

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This has caused a discussion among economists regarding the extent to which wages have contributed to the current inflation. Just in November, during a news conference, the chair of the Federal Reserve, Jerome Powell, stated that he did not believe that wages were the main factor behind the rising prices.

Meanwhile, significant figures in the financial district and government are debating whether workers' salary increase, which has already been decreasing, must undergo additional reduction for inflation to decrease to a level that is considered acceptable by policymakers.

Sonal Desai, the Chief Investment Officer for Franklin Templeton Fixed Income, and a previous economics professor at the University of Pittsburgh, stated that there is a likelihood for unstable inflation due to the high wages. It's not assured that a wage-price spiral will occur, but the wages are significant enough to cause potential instability.

The yearly inflation rate calculated using the consumer price index, which had surpassed 8% at a certain point in the previous year, is currently close to 6%. Another inflation measure that the Federal Reserve favors has consistently diminished since last year. However, it's still staying at around 5%, which is significantly higher than the Fed's aim of approximately 2%.

The job market may contribute to inflation in some way, as higher income can increase people's ability to purchase needs and wants. However, Omair Sharif, who heads up the firm Inflation Insights, which specializes in researching, analyzing and predicting changes in the consumer price index, has doubts that wage increases are the main reason for inflation, even in service industries where much of the work relies on human labor.

Powell has publicly stated that the fluctuation of prices can be attributed to the pandemic, the disruption of supply chains, the ongoing conflict in Ukraine, and sudden changes in consumer spending patterns.

However, the trajectory of expenses related to workers remains significant in terms of the foundation of inflation known as the “fundamental inflation” rate. It represents the extent to which prices would naturally increase without any sudden disruptions.

Powell addressed a congressional committee in March and suggested that the current high inflation may be due to the lack of available workers. Previously, in the fall, he acknowledged that having high wages can be positive, but only if it is accompanied by a stable inflation rate of 2%.

In a recent statement, Jason Furman, an economist hailing from Harvard and who previously led the Council of Economic Advisers under President Barack Obama, highlighted that there has been ongoing wage growth at a rate of approximately 5%. He suggested that this rate is typically indicative of an annual inflation rate of around 4%.

The Federal Reserve has acknowledged the widely accepted belief by persistently increasing interest rates. This move aims to increase the expense of borrowing for individuals and enterprises, with the intention of decreasing their consumption. The Federal Reserve hopes this will also reduce employer's inclination to provide salary increases or hire, thus impeding the possibility of a cycle of inflation caused by higher wages resulting in higher prices.

The Federal Reserve's data in 2022 revealed that the year's median annual salary boosts hit a high point, but it was still within the usual range of 3% to 7%. This range has been consistent since the 80s until the recession that happened between 2007 and 2009. This period witnessed both low and high inflation. Nonetheless, the current situation is much different than the past battles against inflation, as stated by José Torres, a senior economist at Interactive Brokers. This difference can be attributed to the Federal Reserve's recent policy target, which was established in 2012, of approximately 2% inflation.

Torres expressed that it's more challenging to decrease an inflation rate from 5% to 2% as compared to decreasing from 8% to 5%.

Based on the predictions made by the Fed, inflation is expected to be around 3% to 4% towards the end of the current year. This will be accompanied by a significant rise in unemployment rates, which are expected to reach approximately 4.5% as opposed to the 3.6% recorded in February. This spike is expected to result in the loss of jobs, which could vary between 1 million to 2 million, depending on the estimation made. Additionally, the Fed has projected negative economic growth throughout the latter three quarters of this year.

A team of economists working at Cleveland Fed, whose research is not influenced by the Fed policy choices, predict a tougher dilemma between the job market's strength and inflation. In their report released in January, they revealed that attaining nearly 2% inflation by the end of 2025 would demand a severe recession with the unemployment rate doubling.

During the early 1980s, the Federal Reserve took action to eliminate high levels of inflation from the economy. This led to certain outcomes being observed.

If more people from different social classes were to lose their jobs, similar to what happened during the recession in 2008, it would probably have a negative effect on the prices of non-essential items. However, some people disagree with the Federal Reserve's pessimistic predictions and their ongoing effort to reduce access to credit, arguing that this kind of suffering is not required.

Over time, they debate that inflation can subside without countless individuals losing their way of making a living or an enhanced probability of obtaining a salary increase.

According to Bespoke Investment Group, a company that conducts research and manages money, it's highly probable that inflation will decrease to below 4% by June, and may even approach 3%.

According to a way of measuring wage changes over the past three months, the amount of annual wage increases has decreased to 3.6%, which is the lowest it has been since March 2021. This was a time when inflation was hovering at its low levels seen in the 2010s. Nevertheless, unemployment claims are still relatively low in many industries because consumer spending has slowed down from its rapid increase after pandemic restrictions were lifted. However, the current spending rate is similar to what was seen before 2020, so companies still have the need for employees.

According to Josh Bivens, who works as the top economist at the Economic Policy Institute - an organization with liberal beliefs - there is often a decrease in wage growth and prices when unemployment rates rise. However, due to the unpredictable and unusual events that have occurred in recent times, wages cannot be relied upon as a clear indicator at present.

Several people have claimed that instead of having a plan to combat inflation that could lead to more people losing their jobs, companies could discover different ways to be more efficient or boost productivity. Alternatively, profit margins may decrease from their current state, which is the greatest they've been since the 1950s.

Bivens’ study discovered that the amount of profit markups has decreased slightly. In the fourth quarter of the previous year, this only accounted for around 33% of price increases, compared to over 50% during the same period in the year before. However, these marks still remain elevated when compared to a baseline, which previously hovered around 13% in past business cycles.

Skanda Amarnath, who used to work for the Federal Reserve Bank of New York and is now the executive director of Employ America - a nonprofit organization that advocates for creating more jobs - said he can see why people are upset. Amarnath believes those who view restricting job and wage growth as a lack of creative solutions to tackle inflation are entirely correct.

Lately, he and his coworkers have been partaking in dynamic discussions within the community, where diverse opinions are being shared relating to the government's reforms or adjustments in multiple areas such as healthcare, energy, housing, immigration, competition, tax policies, and others. These dialogues aim to come up with solutions that can help reduce prices.

However, certain concepts remain purely hypothetical for the time being due to stymied politics and stagnant policy-making.

According to Diane Swonk, the chief economist at accounting firm KPMG, there are definitely more compassionate ways to handle the situation. However, the most important thing to understand is that the Federal Reserve has a legal obligation to maintain stable prices in a reasonable time frame.

Towards the end of the previous year, Powell admitted that the economy and job market might undergo some significant changes for the long haul, which could ultimately reduce any inflationary stresses.

He warned that it would take a while to put these policies into practice and see their impact. Nonetheless, he emphasized that we need to slow down the growth of labor demand in the meantime.

The section of the blog was published by The New York Times Company in the year 2023.