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Inflation and Wages – Raising the Bar

9.10 / 8.50 / 8.30 / 8.20

Floor / Bars / Beam / Vault?

So, I haven’t gotten the opportunity to put together an article to discuss my daughter’s recent gymnastics competition scores (although I’d take the 8.20 on the vault as that’s been particularly challenging). These numbers are actually the reported monthly consumer price index (CPI) figures for the last four months from June through September of 2022. The CPI provides an ongoing metric to gauge inflation. Here’s a heat map of the monthly CPI figures going back to 2018:

heat map of the monthly CPI figures going back to 2018

Through the first three months of 2021 there were recurring statements by the Federal Reserve that identified inflation as “transitory” and a result of a myriad of factors as the world began to emerge from the impacts of the COVID-19 pandemic. There is no doubt that an unprecedented whirlwind of economic shocks to supply chains, demand cycles, and energy costs have provided a spark to relatively dormant inflation, but when, and why does inflation start to become more persistent rather than a transitory blip on the radar?

I’ll discuss a quick phenomenon here called the wage-price spiral, which could be a significant contributing factor in what is becoming more persistent and entrenched inflation.

The wage-price spiral exists when consumers, in the face of expected and recurring price increases utilize their career positioning push for higher wages. These higher wages increase input costs to businesses which in turn put upward pressure on the price of their goods and services. If those prices then increase again, the consumer again needs to push back for higher wages…and around and around we go.

There is a massive amount of data that could be analyzed, but at a quick snapshot, here’s a chart of total average hourly earnings of all employees:

Average Hourly Earnings of All Employees from 2017 to 2022

*The table includes rates through July since August and September figures are reported as projected from the Bureau of Labor Statistics.

This particular data set appears to support the wage-price spiral concepts. I believe there to be two factors that can encourage the wage-price spiral to have a more dramatic effect.

  1. The duration of prolonged inflationary pressures
  2. Tightness in the labor market

The wage-price spiral becomes increasingly impactful the longer that inflation remains elevated. If my gymnastics daughter is the consumer and me telling her to make sure she’s pointing her toes for the best score is inflation, I assure you, I can only bring that up to her so many times before I get punched. In the same way, consumers can weather a little bit of a storm, but if it carries on too long, an action to improve their wages through a raise, job transfer, or career change becomes increasingly justifiable.

This transitions right into the second factor. If companies are strapped to maintain or recruit talented employees, they will provide compensation incentives to attract the best candidates. When employees see those opportunities, they are more inclined to push their current employer on compensation or be willing to make a change to obtain the necessary compensation to maintain their lifestyle.

The unemployment rate stands at 3.5% as of the end of September.

It seems we may be experiencing these conditions to foster a wage-price spiral and create a period of prolonged elevated inflation or perhaps causing it’s continued increase from current levels. With all of this information it’s simple to raise the question, well, what happens from here? Insert the federal reserve and its dual mandate of maximum employment and low and stable inflation. Interestingly, as inflation currently stands and considering the concepts of the wage-price spiral in discussion, those mandates are looking to be at odds with one another.

The Federal Reserve is reacting to persistent inflation with more aggressive monetary policies in an attempt to cool demand. One of these tools includes increasing interest rates through increases in the federal funds rate (FFR), which the Federal Reserve has done to the tune of 75 basis point increases in each of their last three meetings.

The last time the United States was battling significant inflation was in the late 1970’s and early 1980’s when annual CPI increases exceeded 10% per year. A comparison of the monthly CPI percentage increase to the FFR between September 1979 and July 1982 is identified below:

A comparison of the monthly CPI percentage increase to the FFR between September 1979 and July 1982 is identified

*Information obtained from the Bureau of Labor Statistics and FRED economic data.

Once inflation was entrenched it took nearly three years of a federal fund rate in the double digits and the U.S. Prime Rate peaking at 20% in April 1980 to finally get inflation to recede in 1982, by which time the gross domestic product was approximately -2% and unemployment was approximately 11%.

If a wage-price spiral is in fact permeating the economy, it may be likely that the efforts of the federal reserve to stem inflation are going to require increasingly aggressive monetary policy and additional interest rate increases. This is where things get very interesting. Years of low interest rates have generated large amounts of debt in the economy which will be very susceptible to interest rate increases, especially if they happen quickly. Here are two historical charts of organizational and household debt in the economy.

Here are two historical charts of organizational and household debt in the economy.
Here are two historical charts of organizational and household debt in the economy.

During the high inflation periods of the 70’s and 80’s Ronald Reagan quoted, “Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hit man.”

Will the Federal Reserve agree with Reagan’s vivid description and aggressively move to snuff out inflation or are the ramifications of aggressive tightening to a leveraged economy too risky?

Ongoing worldwide uncertainty and the added fuel of a wage price spiral don’t seem to indicate that inflation is going to go away on its own. So, in the meantime, it is all eyes on inflation and the Federal Reserve response. The Federal Reserve’s goal will be to stick their perfect 10 (“soft”) landing, but I’d hold on tight, that landing may not be as quick or as soft as you are hoping.

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