The World In 2s — Wage Growth And Inflation

Summary

The article discusses the relationship between wage growth, inflation, and the Federal Reserve's monetary policy, suggesting that the Fed prioritizes controlling inflation over supporting real wage growth, often leading to job market sacrifices.

Abstract

The article, titled "The World In 2s — Wage Growth And Inflation," delves into the dynamics of wage growth in the context of inflation and the Federal Reserve's actions. It highlights that while wage growth and inflation are naturally correlated, with companies passing on higher labor costs to consumers, real wage growth—adjusted for inflation—is often negligible or negative. The Fed's response to any sign of positive real wage growth is to raise interest rates, which historically leads to a weakening of the labor market and often triggers a recession. The piece criticizes this approach, arguing that it amounts to blaming workers for inflation and using them as a tool to control it, rather than addressing underlying supply-side issues that could alleviate inflation without harming wage growth.

Opinions

The author implies that the Fed's policy of raising interest rates in response to wage growth that outpaces inflation is a form of gaslighting, suggesting that workers are to blame for inflation.
It is argued that the Fed's preference for raising rates to combat inflation is a simplistic solution that avoids the more complex task of addressing supply-side constraints, such as the housing supply.
The article points out that real wage growth is often minimal and that the Fed's actions to curb inflation quickly reverse any gains made by workers, leading to a loss of purchasing power.
The author criticizes the lack of effort to find solutions that do not harm real wage growth, hinting at a bias towards protecting asset prices and the interests of the wealthy.
There is a suggestion that the Fed's monetary policy inadvertently uses the job market and workers as "cannon fodder" in the fight against inflation, prioritizing asset values over the economic well-being of the average person.

Pic 1: Where’s the real wage growth?

Wage growth (blue) tracks inflation (red and green) and rarely exceeds it (Source: Federal Reserve Bank of St. Louis)

It makes sense that wage growth and inflation are correlated — when wage growth is high, companies’ costs rise, and those companies do their best to pass those increased costs back onto consumers via rising prices. Also, high wage growth tends to also be an indicator of a tight labor market and a fast growing economy — both drivers of aggregate demand and thus inflation. That’s why the Fed keeps indicating that there will be more rate increases to come. Until the labor market weakens further, central bankers maintain that they have no choice but to “stay vigilant.”

But looked at another way, normal people are being gaslighted into thinking that they’re the problem. Basically, policy makers are saying that it’s employees’ faults that prices are rising — people are just getting paid too much. And the only way to keep prices down is to either pay everyone less or to fire a bunch of people. But if you stare hard at the above graph, wage growth (the blue line) often lags behind both inflation (red line) and core inflation (green line). Which means that real wage growth is negligible and often negative (i.e. people are losing buying power) — and the second that positive real wage growth comes around, the Fed slams down the interest rate hammer.

Pic 2: There is no consistent real wage growth thanks to Fed monetary policy

When real wage growth (blue) goes above zero, interest rates (red) get increased not long after (Source: Federal Reserve Bank of St. Louis)

In the above chart, notice two things. First, the green line (real wage growth, a.k.a. wage growth less inflation) is often below zero and some of its largest positive spikes are during recessions when unemployment is spiking and inflation is either zero or negative. Real wage growth during deflationary times is not really growth because many people end up fired.

Second, anytime that real wage growth (green line) enjoys a short period of being positive, as long as we’re not in a recession (gray bars), the Fed raises interest rates (red line) not long after, ultimately producing a recession. Yes, the rate rises are to combat rising levels of inflation but that doesn’t change the unfortunate fact that the preferred cure for inflation kills real wage growth.

Unfortunately, raising rates to fight inflation is easy relative to the alternatives and policy makers prefer easy. It would be much harder to find supply-side solutions such as increasing the supply of housing and so they don’t (also because doing so would hurt asset prices and the wealthy and connected hold the most assets). And so normal people are used as cannon fodder in the war against inflation.

The World In 2s — Wage Growth And Inflation

The Fed is willing to sacrifice the job market for lower inflation

Pic 1: Where’s the real wage growth?

Pic 2: There is no consistent real wage growth thanks to Fed monetary policy