As Covid-19 eased its debilitating grip on the U.S. economy two years ago, businesses scrambled to hire. That lifted the pay of the average worker. But as one economic challenge ended, another potential problem emerged.
Many economic analysts feared that a wage-price spiral was forming, with employers trying to recover the higher labor costs by increasing prices, and workers in turn continually ratcheting up their pay to make up for inflation’s erosion of their buying power.
As wages and prices have risen at the fastest pace in decades, however, it has not been an evenly matched back and forth. Inflation has outstripped wage growth for 22 consecutive months, as calculated by economists at J.P. Morgan.
That has prompted economists to debate how much, if at all, pay has driven the current bout of inflation. As recently as November, the Federal Reserve chair, Jerome H. Powell, said at a news conference, “I don’t think wages are the principal story for why prices are going up.”
At the same time, influential voices on Wall Street and in Washington are arguing over whether workers’ earnings growth — which, on average, has already slowed — will need to let up further if inflation is to ease to a rate that policymakers find tolerable.
Year-over-year percentage change in earnings vs. inflation through February
+8%
CONSUMER
PRICE INDEX
+6.0%
+6
AVG. HOURLY
EARNINGS
+4.6%
+4
+2
2019
2020
2021
2022
2023
+8%
CONSUMER
PRICE INDEX
+6.0%
+6
AVG. HOURLY
EARNINGS
+4.6%
+4
+2
2019
2020
2021
2022
2023
Note: Data is seasonally adjusted.
Source: Bureau of Labor Statistics
“We aren’t saying that we’re going to get a wage-price spiral,” said Sonal Desai, a former economics professor at the University of Pittsburgh who is the chief investment officer for Franklin Templeton Fixed Income. “However, wages are high enough that inflation is potentially unstable.”
The annual rate of inflation as measured by the Consumer Price Index, which exceeded 8 percent for a time last year, is lingering near 6 percent. A separate inflation gauge preferred by the Federal Reserve has steadily cooled since last year — but it’s hovering around 5 percent, far above the Fed’s goal of roughly 2 percent.
The labor market is at least indirectly responsible for some share of inflation, since higher income helps people afford necessities and spend on desires. But Omair Sharif, the president of Inflation Insights, a private firm providing research, analysis and forecasts of the Consumer Price Index, said he was “quite skeptical” that wage gains were a primary cause of inflation even in labor-intensive service industries.
Mr. Powell has publicly made the case that the pandemic, the discombobulation of supply chains, war in Ukraine and volatile shifts in consumer spending trends are primarily responsible for price instability.
What is inflation? Inflation is a loss of purchasing power over time, meaning your dollar will not go as far tomorrow as it did today. It is typically expressed as the annual change in prices for everyday goods and services such as food, furniture, apparel, transportation and toys.
What causes inflation? It can be the result of rising consumer demand. But inflation can also rise and fall based on developments that have little to do with economic conditions, such as limited oil production and supply chain problems.
Is inflation bad? It depends on the circumstances. Fast price increases spell trouble, but moderate price gains can lead to higher wages and job growth.
How does inflation affect the poor? Inflation can be especially hard to shoulder for poor households because they spend a bigger chunk of their budgets on necessities like food, housing and gas.
Can inflation affect the stock market? Rapid inflation typically spells trouble for stocks. Financial assets in general have historically fared badly during inflation booms, while tangible assets like houses have held their value better.
Yet the arc of employee costs is still central to what economists call the “underlying inflation” rate: the level of upward price pressures that would presumably exist even without destabilizing shocks.
On that score, Mr. Powell told a congressional committee in March that “some part of the high inflation that we’re experiencing is very likely related to an extremely tight labor market” — building upon his assessment in the fall that “strong wage growth is a good thing, but for wage growth to be sustainable, it needs to be consistent with 2 percent inflation.”
Jason Furman, a Harvard economist who headed the Council of Economic Advisers under President Barack Obama, noted recently that wage growth had still been running around 5 percent, an annual rate that he said was “usually consistent with about 4 percent inflation.”
The Fed has followed up on that mainstream consensus by continuing to raise interest rates — taking the cost of borrowing for people and businesses even higher in hopes of discouraging their spending and, in turn, reducing employers’ inclination to hire or give raises, cutting off the threat of a wage-price feedback loop.
In 2022, Fed data showed median annual pay gains hit a peak still within the range — 3 to 7 percent — that prevailed from the 1980s until the 2007-9 recession, a period that included both low and high inflation. But “the world is a lot different” than it was during past inflation fights, said José Torres, a senior economist at Interactive Brokers — including the Fed’s official policy target of roughly 2 percent inflation, which was set in 2012.
“Getting from 5 down to 2 is a lot harder than getting from 8 down to 5,” Mr. Torres said, referring to the percentage rate of inflation.
According to the Fed’s projections, inflation will be between 3 and 4 percent by the end of this year, accompanied by a jump in unemployment to 4.5 percent from the 3.6 percent in February — a loss of one million to two million jobs, depending on the estimate. The Fed is also projecting economic contraction over the remaining three quarters of this year.
A group of staff economists at the Cleveland Fed — whose work is independent of Fed policy decisions — foresee an even more painful trade-off between inflation and the strength of the labor market. In a January paper, they said that approaching 2 percent inflation by late 2025 would require “a deep recession,” with a doubling of the unemployment rate.
Those were the kinds of effects seen in the early 1980s, as the Fed moved to purge double-digit inflation from the economy.
A broad-based rise in layoffs that extends to the middle class and the well-off — as happened in the 2008 downturn — would likely dampen inflation for more discretionary goods and services. But critics of the Fed’s somber calculations and its continued tightening of credit say that such pain isn’t necessary.
With time, they argue, inflation can ease without millions losing their livelihoods or a better chance at a pay raise.
Bespoke Investment Group, a research and money-management firm, believes there is a firm chance that inflation is on a path to fall below 4 percent by June, possibly near 3 percent.
By one measure meant to capture up-to-date movements in the three most recent months of data, the annual rate of wage gains has slowed to 3.6 percent, the lowest since March 2021, when inflation was fluttering around its tame 2010s levels. At the same time, jobless claims remain low in most sectors, as consumer spending has slowed from its surge after the pandemic reopenings but is comparable to pre-2020 trends, keeping staffing needs in place.
Josh Bivens, the chief economist at the Economic Policy Institute, a liberal think tank, said that while higher unemployment generally curbs wage growth and price pressures, wages “are no guide at all” right now with “the unexpected and weird shocks we’ve had over the past couple of years.”
Many have argued that in place of an anti-inflation strategy that anticipates higher unemployment, businesses could find other efficiencies or productivity improvements — or profit margins could retreat from current levels, which are the highest since the 1950s.
According to Mr. Bivens’s research, profit markups have “relented a bit” — accounting for about a one-third share of price increases in the fourth quarter of last year, down from more than half in the comparable period in 2021 — but are “still quite high relative to a baseline,” which has been closer to 13 percent in previous business cycles.
Skanda Amarnath, a former staff member at the Federal Reserve Bank of New York and the executive director of Employ America, a nonprofit that pushes for maximizing employment, said he understood why people were aggrieved. Those who see reliance on curtailing the growth of employment and wages as a “failure of imagination” in the fight against inflation are “so spot on,” Mr. Amarnath said.
He and his colleagues have been involved in the lively, ideologically diverse public debates that have emerged about ways that government reforms or regulatory adjustments — in health care, energy, housing, immigration, competition, tax policy and more — could ease prices.
But some ideas are, for now, only thought experiments: a result, many say, of political gridlock and policy inertia.
“Are there ways out of this that are a kinder, gentler form? Absolutely,” said Diane Swonk, chief economist at the accounting firm KPMG. But “the bottom line,” Ms. Swonk said, is that the Fed has a statutory duty to pursue mild, stable prices in a timely manner.
Late last year, Mr. Powell acknowledged that longer-term structural changes to the economy and labor market could ease inflation pressures.
“Such policies would take time to implement and have their effects, however,” he cautioned. “For the near term, a moderation of labor demand growth will be required.”