MNI INTERVIEW: Cleveland Fed Econ. Sanguine on Wage Inflation

Productivity gains and rising profits should help U.S. firms absorb the cost of higher wages, muffling the inflationary impact of a job market boom and increased worker bargaining power, Cleveland Fed economist Robert Rich told MNI.

“There’s this narrative that there’s this very straightforward linkage between wages and prices, and the moment you see wage increases that’s going to immediately translate into price inflation,” said Rich, director of the Cleveland Fed’s Center for Inflation Research as well as a senior economic and policy advisor to the Bank's president, Loretta Mester.

“It’s not a narrative we think of as being accurate. You could think of there being lots of slippages, at least in the near term, between wages and prices.”

For one thing, said Rich, the pandemic has created productivity gains for many firms that have allowed them to offset increased wage costs. Companies are also raking in record profits, giving them enough of a cushion to not always pass on cost increases.

“Some firms may be willing, at least in the short run and depending on the extent of their pricing power, to absorb some kind of wage increases in their profit margins rather than necessarily passing them through into prices,” said Rich.

The U.S. job market has recovered at an unusually rapid clip from the Covid recession, with the jobless rate slipping to just 3.9% in December. Average hourly earnings jumped 0.6% on the month and 4.7% in the year, well above market expectations for a 4.2% gain.

This and other signs of labor market tightness, including record openings and quits and reports of shortages in many sectors, have prompted some concerns that workers’ wage demands might become a major source of inflationary pressure. (See MNI: Services Inflation Seen As The Fed's Next Big Problem and MNI INTERVIEW: Fed Inflation View Still Too Benign- Blanchard)

GREAT EXPECTATIONS

Rich conceded the trend bears watching, but argued that contained long-term inflation expectations for now suggest the jump in wages is not likely to be repeated on an ongoing basis.

“I recognize that right now, pass-through from wages to prices, there’s a greater likelihood of that happening in the current environment. Some firms have more pricing power than before so there’s opportunity for some pass-through and we’re seeing some pass-through in some sectors,” he said.

“But that wage-price spiral is something that’s going to require a change in inflation expectations,” Rich added. “It’s very important to monitor their behavior to ensure that they remain well anchored and any risk of their becoming unanchored and moving to the upside is something that would be very notable and would require a great deal of attention.”

In particular, Rich said he’s focused on longer-term inflation expectations as measured by the five-year five-year forward imputed from the Survey of Professional Forecasters. Despite jumps in shorter-term expectations one-year out, those measures are still pointing to expectations of just about 2%, said Rich.

“To me, that’s the area, or the horizon in which monetary policy is going to have a much more direct impact on inflation because a lot of the near-term movements in inflation, some of that can’t be controlled by monetary policy,” he said.

“But when you start getting to that five-year five-year forward horizon, you get a much cleaner measure of inflation and in particular a much cleaner measure that can be impacted by monetary policy.”

Consumer prices soared far beyond Fed officials’ and market expectations over the course of 2021, surging 6.8% in the year to November. The Fed’s preferred PCE measure jumped 5.7% over the same period.