Home Economy Employees expect rapid inflation next year. Could it become a reality?

Employees expect rapid inflation next year. Could it become a reality?

by SuperiorInvest

Amitis Oskoui, a consultant who works mostly with nonprofits and philanthropies, hasn’t seen a pay raise since inflation began to take a toll on her earlier this year. What she did have are job offers.

Ms. Oskoui, 36, tried to use those prospects to argue for a raise as the rising cost of food, childcare and life in general in Orange County, Calif., made cuts to her family’s budget.

“Generally, in the past, it was taboo to say, ‘I need this to survive, and I know my market value,'” she said. “In this environment, I think it’s more acceptable. Inflation is so front of mind and a big part of the public conversation about the economy.”

This logic, reasonable on an individual level, unnerves the Federal Reserve as it reverberates across America.

When employees successfully push for pay increases to cover their cost of living, companies face higher wages. To offset these expenses, firms can raise prices, creating a cycle in which rapid inflation today begets rapid—and perhaps even faster—inflation tomorrow.

Fed Chairman Jerome H. Powell said on Wednesday that Fed officials do not yet think that wage growth has been the primary driver of rapid US inflation.

But the jobs report due out on Friday is likely to show that average hourly earnings rose by 4.7 percent economists predict for the last year. That’s much faster than the three percent pace that prevailed before the pandemic, and it’s so fast that it is could make it difficult for inflation to disappear completely. Moreover, policymakers remain concerned that today’s pressures could yet turn into a spiral in which wages and prices chase each other higher.

If that were to happen, it could make it harder to contain inflation — which is the main reason the Fed is adjusting its policy quickly. Central bankers raised interest rates by three quarters point this week and signaled they would raise them further in an effort to slow the economy and fight price rises fast enough to curb inflationary expectations.

Some measures of short-term inflation expectations have risen recently, meaning people expect prices to continue rising, at least for a while. That “may be important in the wage-setting process — there’s a school of thought that believes that,” Mr. Powell said this week. “So that’s very disturbing.

Economists typically focus on longer-term inflation expectations because short-term expectations bounce around a lot in response to gas and food prices, which are volatile. These longer-term measures offer more encouraging news: They stay low across a range of survey-based measures even after 18 months of rapid inflation.

But as Mr. Powell mentioned, some economists believe that short-term inflation expectations could affect what workers demand during wage negotiations. When people see daily price increases, they may want to cover these expenses, even if they believe inflation will decrease in the long run.

“With inflation as high as it is, it’s on people’s minds a lot,” said Karen Dynan, an economist at Harvard. As for short-term expectations as a wage driver, she said, Mr Powell “is right when you look at it: there is a basic logic to it”.

Therefore, recent trends in short-term expectations are somewhat worrying, to say the least. Since late summer, some measures short-term inflation expectations they roseand even those which did not remain very high.

In one survey of global employers released this summer by insurance consultancy WTW, 47 percent of those raising wages more than originally expected in 2022 said they were responding to workers’ concerns and expectations.

Workers say anecdotally that they are asking for higher pay due to rising costs. Ms. Oskoui, who moved to California from New York during the pandemic to be near family, expects to get a raise this year — perhaps 5 percent. But that would not be as big a step as she would like.

People like Ms. Oskoui have a great chance to earn more if they leave their employers. The labor market is abnormally strong, with a large number of vacancies and a shortage of applicants, and a gap between how much wages are growing for people who leave and those who stay unusually large: 7.1 percent versus 5.2 percent, based on the latest data from the Atlanta Fed tracking wage growth.

This is where the Fed’s policy tools could prevent a tighter grip on wage-driven inflation. The central bank expects that by limiting economic demand and slowing the economy, its higher interest rates will eventually drive the unemployment rate up. With more people out of work and applying for jobs, employers may have less competition and it will be more difficult for workers to earn big salaries.

It’s likely to be a painful process for workers — something Fed officials acknowledge. But they argue that it would be even worse to let inflation rise for so long that it became a key part of how future wages and prices were set. Once inflation is entrenched, bringing it down may require an even greater fall in demand and a greater rise in unemployment.

Part of the problem is that no one knows exactly when inflation will turn from temporary to embedded. Economists don’t understand inflation that well: they regularly disagree on it whether expectations even matter, which are important and why. Models based on historical data can offer little guidance for today.

“We don’t have a clearly identified scientific way to understand at what point inflation takes root,” Mr Powell said on Wednesday.

America has not had much recent experience with rapid inflation. Price growth took off in the 1970s and appeared to be self-sustaining, but has been mostly low and steady since the 1980s. And today’s experience is very different from 50 years ago: Workers are less unionized, which could make them less likely to win higher wages wholesale. But the population is also aging and immigration is slow, which could keep pressure on workers to pay more to compete for labor.

Given the uncertainties, the Fed is focusing on reducing inflation quickly.

“The thing we have to do from a risk management perspective is use our tools forcefully but thoughtfully and get inflation under control, get it down to 2 percent and get it behind us,” Mr. Powell said.

While he doesn’t think America is in a wage-price spiral, he said, that’s no cause for complacency.

“Once you see that, you’re in trouble, so we don’t want to see that,” Mr. Powell said. “We want wages to rise. We just want them to go up to a level that is sustainable and consistent with two percent inflation.”

The central bank is likely to discuss slowing rate movements at its December meeting, Powell said. But even if officials move at a modest pace, they are likely to push borrowing costs above the 4.6 percent level they had previously forecast, he suggested.

The aggressive way may become more of a challenge next year if economic activity and the labor market begin to decline, even if inflation persists. Still, Mr. Powell’s nod to inflation expectations this week underscores why the central bank is determined to stay the course: It thinks economic pain is now better than sustained inflation.

“Maybe he’s setting the stage to say, ‘This is why we have to stay hawkish,'” said Priya Misra, interest rate strategist at TD Securities. “We don’t want them to take up residence.

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