Price inflation is at its highest level in 40 years – 8.5% year-on-year, according to the March report consumer price index. Wages haven’t quite kept pace: the average hourly wage has increased 5.6% over the same period, according to the Labor Department’s March employment report.
Federal Reserve Chairman Jerome Powell has expressed concern about the wage part of this equation. He said the labor market is stretched to an “unhealthy” level and that the acceleration in wage gains “would not be sustainable over too long a period”.
What worries some economists, and what the Fed is trying to prevent, is that the US economy slips into a “wage-price spiral”. This happens when rising wages cause companies to raise prices, which in turn causes workers to demand wages that keep pace with inflation. Etc. Once this cycle has started, it can be difficult to stop it, as policymakers learned in the early 1980s.
In an attempt to better understand the link between wages and prices in recent periods of high inflation, the economic historian Thomas Stapleford from the University of Notre Dame suggested that we look back in history — long before times of high inflation like the aftermath of World War II and the American Revolution.
“Four thousand years ago,” Stapleford said, “in the Code of Hammurabi, well, ancient Babylon, they tried to set prices: for renting animals, how much you would pay to rent a cart , pay a surgeon’s fee, pay for wheat or for grain.
Stapleford said that in the ancient period wages and prices were treated alike in officials’ efforts to control inflation.
In our modern economy, wages and prices can spiral out of control if there is a classic wage-price spiral. “As consumers fear that prices will go up in the future,” Stapleford explained, “first of all, they’re going to try to buy things now because they want to lock in something at a price — the price existing – before it goes up. But they will also push for higher salaries.
That’s what happened in the 1970s and early 1980s, when high levels of inflation comparable to what the U.S. economy has seen in recent months lasted for much of decade. (From 1973 to 1975 and from 1978 to 1982, the CPI remained above 7.5%, peaking at 14.5% in March 1980.)
Columbia University economist and former Governor of the Federal Reserve. Frederic Michkin said the economy faces similar risks today. “I think we are currently in a wage-price spiral. If workers begin to expect higher inflation, they must demand higher wages or fall behind the eight ball. It’s great if you get a 5% pay raise. But if inflation is expected to be 8%, you can buy 3% less goods next year. So there’s not much point in having a large wage increase, if in fact inflation increases further.
Mishkin argues that the Federal Reserve did not act quickly enough or decisively enough to control prices and wages. “When you’re in a situation where the central bank is losing credibility, people aren’t as confident that they’re going to control inflation,” he said. “This is exactly when workers and businesses are going to end up with higher wages. And that’s what we see now.
Some analysts, however, believe that we are not quite in a wage-price spiral. “I don’t think we’re necessarily anchored in one yet, but I think the risk is very clear and very present,” the investment strategy analyst said. Ross Mayfield at Baird, which is a Marketplace underwriter. Mayfield said what’s fueling inflation right now is primarily the pandemic and the war, not workers’ wage demands. “A lot of people understand that it’s both COVID-related and Ukraine-related. Long-term inflation expectations remain reasonable. They’re not out of the norm yet.
(The New York Fed’s most recent survey of consumer inflation expectations is here.)
There is also a camp among economists that considers the risk of a wage-price spiral leading to higher inflation now, or at any time, to be minimal.
Economist Joe Brusuelas consultancy firm RSM said workers simply did not have the power to drive wages higher and higher. He said the tight labor market – mainly due to pandemic-induced labor shortages and changing demographics – is the main cause of salary increases at the moment.
“This is not a wage-price spiral tied exclusively to inflation as we saw in the 1970s,” Brusuelas said. At this moment, unions accounted for about 1 in 4 American workers.
“Back when unions played a much bigger role in the economy, many contracts were tied to inflation,” Brusuelas continued. “In the late 1970s, the United Mine Workers were able to secure a nearly 12% wage increase – in one year – tied specifically to inflation.”
Brusuelas pointed out that while Social Security retirees now receive automatic annual cost-of-living adjustments, very few workers do.
He said companies have been able to pay higher prices for supplies and higher wages to attract workers, without hurting their profit margins. For him, this is proof that the pressure to raise wages does not harm employers or the economy.
Meanwhile, that pressure is helping low-income workers whose wages have lagged for decades. “What we’re seeing is a wage reset — especially for low-income cohorts,” Brusuelas said. “Working class, poor and lower middle class America are seeing rising wages.”
“Higher wages are a good thing in the American economy and not to be feared,” continued Brusuelas. “We don’t have a classic wage-price spiral, and that can never be repeated enough.”
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