- The longer inflation stays hot, the higher risk workers will demand more pay.
- That could lead firms to raise prices, kicking off a “wage-price spiral” and keep inflation high.
- The IMF says risks of that are low, but some economists aren’t so sure. Some say one’s already here.
Good news: wages are expected to continue rising. Bad news: wages are expected to continue rising.
How much wage increases are contributing to four-decade high inflation could determine whether we’re seeing what economists call a “wage-price spiral” and could help unlock how high inflation may climb and how long it will stick around.
The question is so key that the International Monetary Fund devoted an entire chapter to unpacking the answer in its World Economic Outlook this month.
A wage-price spiral is when higher prices lead workers to demand higher wages, which in turn increases costs and pushes prices still higher, setting off a loop.
In the second quarter, wages accelerated 5.1% annually, below the inflation rate but the fastest clip since the series began in the first quarter of 2002.
The IMF concluded risks were low, but some economists believe the U.S. is either already in a spiral or entering one as people chase inflation higher.
“Every month inflation remains high, the risk grows that inflation expectations… move higher too,” Henry Allen, Deutsche Bank analyst, said. “In turn, firms and individuals will factor this into their price-setting and wage-bargaining, and expectations of higher inflation then become a self-fulfilling prophecy.”
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What are the components of a wage-price spiral?
High demand for goods and services causes inflation if companies struggle to meet the demand, which is what happened in the past year to set off the fastest inflation in a generation.
Due to the cost of inflation, workers demand more money. In response, businesses must raise their prices to compensate for the salary increases. As costs spiral higher, so do wages again, and the wage-price spiral continues.
What are signs of a wage-price spiral?
Fed Chairman Jerome Powell has repeatedly suggested that if inflation expectations remain tame and manageable, or “anchored,” a wage-price spiral could be avoided. So far, inflation expectations haven’t jumped too much in surveys the Fed watches, but economists say there are other signs to watch.
September’s consumer price index remained elevated at an 8.2% annual rate. The core rate, excluding the volatile food and energy sectors, jumped 6.6%, the largest gain since August 1982, showing widespread inflation despite the Federal Reserve’s aggressive rate hikes to cool spending.
The Fed’s raised its short-term benchmark fed funds interest rate by 3% this year, and more are expected. These rate increases influence every consumer rate, including mortgages, auto loans and savings.
Those numbers alone are worrisome, but report details reveal an even more alarming inflation picture, some economists say.
“If you want a wage-price spiral, look in core services (excluding) shelter to see if it’s happening,” said Michael Ashton, founder of Enduring Investments.
What does core services inflation show?
Core services inflation, which excludes energy and is seen as long lasting because these prices tend to change slowly and incorporate long-term inflation expectations, accelerated to a 40-year high of 6.7%. Even without the heavily weighted, lagging and accelerating rent, or shelter, category, it rose 6.6%.
And “some businesses said elevated inflation and higher costs of living were pushing wages up, coupled with upward pressure from labor market tightness,” the Fed’s Beige Book said last week.
This “not even stabilizing, but accelerating is seriously bad news and raises the prospect that inflation will not decline as rapidly as investors expect over the months ahead,” Allen said.
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Are there other signs of a wage-price spiral?
Yes.
In index data, monthly food-at-home inflation dipped to 0.69% in September from August’s 0.75%. However, food away from home, like restaurants, rose to 0.94% from 0.87%.
“This is bad,” Ashton said. “Food commodities are leveling off a little, but wages show up in food away from home.”
Wages have also risen even as productivity has dropped, meaning employers are paying more for less. Labor costs usually move in tandem with productivity.
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Second-quarter productivity slumped 4.1% from the first quarter and 2.4% from last year, the largest decline since the series began in the first quarter of 1948.
“That feeds wage inflation,” said Matthew Matigian, Blue World Asset Managers chief executive. “A company has no choice but to pass on those costs to the consumer. That feeds consumer prices, and ‘round and ’round we go!”
Yung-Yu Ma, BMO Wealth Management chief investment strategist, agrees, “a wage-price spiral is already in motion.”
How can the Fed stop the wage-price spiral, if there is one?
“Really, the only lever they (the Fed) have is slowing the economy,” Nathaniel Harmon, research director at market research firm YipitData. “Other options would need to come from legislative, executive policy of some kind.”
That means more Fed rate hikes, analysts say, but they warn the process will be extremely slow.
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“The good news is that this spiral will gradually shrink in magnitude over time,” Ma said. “The bad news is that it will indeed take some time to work, probably more than a year.“
Harmon said his data show wages and income growth reaccelerated into September from August, primarily among lower-income earners.
Ashton expects inflation will slow but probably not fall much lower than 4%, “and it will take some years. I’d get used to inflation being somewhat higher than we were previously used to and get used to it being more volatile than we’d gotten used to.”
How high will rates have to go?
The Fed’s last projections showed the median projection for the fed funds rate topping out at 4.6% next year, but a handful of economists, including former Treasury Secretary Lawrence Summers, predict it will have to go higher.
Deutsche Bank analysts expect the Fed to raise rates by another 0.75% at each of its last two meetings of the year, but that won’t be the end. They, like Summers, forecast the fed funds rate will ultimately have to move to at least 5% from its current range between 3% and 3.25%.
Medora Lee is a money, markets, and personal finance reporter at USA TODAY. You can reach her at [email protected] and subscribe to our free Daily Money newsletter for personal finance tips and business news every Monday through Friday morning.
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