If anyone had told you three years ago that the heavyweight championship bout of the decade would feature the Federal Reserve vs. the job market, you’d have gotten a laugh out of it.
But here we are. The February employment report is out. The U.S. gained 311,000 new jobs last month, down from the half million added in January but still nearly double its pre-pandemic average. Plus, “wages for production and nonsupervisory workers—which make up the majority of U.S. workers—advanced 0.5%, the biggest gain in three months,” notes Bloomberg.
There’s no way the Federal Reserve can let that stand. Even before the report was released, Fed chair Jerome Powell was hinting that bigger, more frequent rate hikes may be needed to kill job growth and hammer wages into submission.
Meanwhile, that evil SOB Joe Biden is actually bragging about job creation as if it’s a good thing.
Obviously there’s a disconnect. Most Americans (employees at least) would say plentiful jobs are in fact a good thing. Economists would agree—except during an inflationary period when they believe we’re at risk of a wage-price spiral.
Here’s how Investopedia explains it: “The wage-price spiral is a macroeconomic theory used to explain the cause-and-effect relationship between rising wages and rising prices, or inflation. The wage-price spiral suggests that rising wages increase disposable income, raising the demand for goods and causing prices to rise. Rising prices increase demand for higher wages, which leads to higher production costs and further upward pressure on prices creating a conceptual spiral.”
That’s what the Fed is trying to prevent. It’s the same approach then-Fed chair Paul Volcker took in 1981-82 after inflation spiked to nearly 15%: Higher interest rates kill investment. Lower investment kills job growth, and fewer jobs kill wage growth. That kills demand for goods and services, which then kills inflation.
Just like a Quentin Tarantino movie.
As always, there is a catch. Some don’t believe raising interest rates will work. “The worry,” explains the Financial Times, “is that a year of rocketing prices may have triggered a lasting change in the expectations and behavior of workers, employers, and consumers.” FT calls it wage-price persistence: Everyone gets used to the idea that everything is going up, and goes about their business regardless of rates.
Others think we’ve got the relationship between wages and prices backwards. The Economic Policy Institute argues that in the past year, wage growth “has lagged far behind inflation, meaning that labor costs are dampening—not amplifying—price pressures.”
Still others say that except in extreme cases (think Germany after World War I), wage-price spirals peter out on their own. A 2022 study from the International Monetary Fund examined 179 historical wage-price spiral “episodes” in advanced economies and concluded that “wage-price spiraling dynamics appear to have short lives.”
IMF found that even without intervention by central banks, “the great majority of the episodes (were) not followed by a sustained acceleration in wages and prices. Instead, inflation and nominal wage growth tended to stabilize in the following quarters, leaving real wage growth broadly unchanged.”
In other words, stop scratching and the itch will go away.
Maybe IMF is right, maybe not. We’ll never know. The Fed is scratching furiously—and determined to keep scratching until we get irritated.