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Are higher wages pushing inflation? The San Francisco Fed took a look

Policymakers at the Fed have been ratcheting up interest rates in an effort to bring inflation back to its target of 2%. Currently, the rate of price increases is more than double that goal. While there are many factors behind the reason for the rising cost of living, one that has been highlighted is nonhousing services inflation and the effect of the tight labor market is having on it.

On Tuesday, the Federal Reserve Bank of San Francisco published a new analysis on the effect that labor-cost growth has on inflation.  SF Fed Vice President Adam Shapiro explains that “labor-cost growth has a small effect on nonhousing services (NHS) inflation, as well as inflation overall.”

“The estimates imply that the recent surge in the employment cost index explains only about 0.1 percentage point (pp) of current elevated inflation readings,” which are a “negligible portion” of the 3% core PCE inflation for nonhousing services.

Since the results of the analysis “cast some doubt” that higher wages are driving inflation there is room for other explanations. Shapiro puts forth that “recent evidence shows that wage growth tends to follow inflation, as well as expectations of future inflation.”

Wage inflation will be one of the features of economic data due out prior to the Fed’s June meeting that experts will be focusing on. It is expected to have slowed month-over-month to 0.3% in May from 0.5% the month before. However, the SF Fed economist says that “recent labor-cost growth is likely to be a poor gauge of risks to the inflation outlook.”