Excellent post. The average annual salary increment does not beat inflation. If that were the case, equity investment wouldn't be a necessity.
The current inflation is a byproduct of labour shortages during the pandemic followed by the rise in energy and food prices due to demand/supply issues.
As you've rightly said, inflation results in higher wages to meet present expenses and not the other way round.
And recently it has especially not even been beating the productivity growth we've now observed for several quarters. I'd also add the resolution of the supply shock and bottlenecks have eased a chunk of the inflationary pressure.
The economic landscape of the 1970s and today presents a fascinating tapestry of parallels and contrasts, shedding light on the intricate dance between demographics and inflationary pressures. In the 1970s, the Baby Boomer generation entering the labor market led to a surge in demand but curbed wages, contributing to double-digit inflation. Contrastingly, today's scenario showcases falling population growth propelling labor costs upward, while labor participation rates in the US hover at around 62%, altering the dynamics of inflationary trends.
During Arthur Burns' tenure as Chairman of the Federal Reserve, the complexities of addressing sticky inflation were evident as price levels remained elevated despite efforts to combat rising inflationary pressures. The challenge of navigating an economy plagued by sticky inflation limited the effectiveness of traditional monetary policy tools, leading to a protracted battle against escalating price levels.
Fast forward to the present day, Federal Reserve Chair Jerome Powell is confronted with a similar dilemma as inflation rates exhibit stickiness, resisting downward adjustments despite contractionary monetary policies. Powell's efforts to combat inflation by implementing measures like interest rate adjustments and tightening monetary policy mirror the challenges faced by predecessors such as Arthur Burns in managing stubborn inflationary trends. The shift in today's scenario isn't due to the surge in demand from the Baby Boomer generation but the contraction in the labour supply, which elevates labour costs and contributes to overall inflationary pressures.
This dynamic interplay between shifting demographics and economic forces underscores the complexities shaping our current economic landscape and highlights the ongoing challenges faced by policymakers in managing inflation in a changing world. Which the markets seem briskly unaware.
A very interesting comparison to make and appreciate the analysis! I wonder how much credibility of central banks has played a part now. Inflation did drop back quite a lot from the highs and inflation worries didn't really manifest themselves into the long run. Correct me if I'm wrong, but I assume in the 70s there wasn't as much belief in the long run inflationary trend.
Definitely, however, the very different labor demographics today have played a major role in many elements of the macro economy.
Thank you! There is no wage-price spiral in the current dynamic. Wages probably need to go up more to even catch up (on the lower-income end) with inflation that's occurred over the past few decades. This is probably the best way for them to go up, too: slowly and over time, and in a staggered natural increase pattern rather than all at once via federal law or regulation.
Yes - wages are definitely below the standard trend of 3.5% since the Great Recession in 2008 (the EPI has a good chart here - https://www.epi.org/nominal-wage-tracker/ ). It's slowly catching up and full employment or close to full employment is helping with that!
And even in the sense that a shock to a price can induce the Fed to engineer above-target inflation to facilitate the adjustment of relative prices to the shock, "wages" is too heterogeneous to be the subject to such a shock.
I agree that a central bank can target any inflation and achieve that inflation in any given time period. Whether that is possible without large welfare costs (maybe if the central bank controlled both fiscal and monetary levels, but even then it is doubtful) is a separate question. Fundamentally, the central bank should maintain price stability while minimizing welfare cost (the central bank implicitly assumes a welfare function) - in the US, that's the implication of the dual mandate (it also appears like other central banks act in the same way even if they don't have the secondary mandate).
The proximate cause of moving out of equilibrium inflation is some form of shock - during the pandemic, it was the supply shock. Central bank responses should be different to different proximate causes of the inflation shock, if the aim is to minimize the welfare cost. The supply shock was large enough to affect basically an entire economy - whether goods via manufacturing shutdowns, port delays or services, via lockdowns. So although shocks to specific industries will be difficult for the central bank to address, a shock to a large section of it should be much 'easier' to address with the tools the central bank has.
Yes - to be more specific, instead of maximum real income, some form of maximization of a welfare function. Maximum real income is a specific objective function and I'm not sure that's necessarily the 'best' function to optimize on, given higher/lower inflation may also impact asset prices. This is where the subjective component of the Fed's remit kicks in.
OK the target inflation is chosen to maximize "welfare" not income. Could you give me an idea of what difference that would make in practice. [And I'll suggest one. :) Maybe "society" prefers an inflation target lower than the one that would maximize "income."] But asset prices?
Excellent post. The average annual salary increment does not beat inflation. If that were the case, equity investment wouldn't be a necessity.
The current inflation is a byproduct of labour shortages during the pandemic followed by the rise in energy and food prices due to demand/supply issues.
As you've rightly said, inflation results in higher wages to meet present expenses and not the other way round.
Also, many thanks for the mention.
And recently it has especially not even been beating the productivity growth we've now observed for several quarters. I'd also add the resolution of the supply shock and bottlenecks have eased a chunk of the inflationary pressure.
The economic landscape of the 1970s and today presents a fascinating tapestry of parallels and contrasts, shedding light on the intricate dance between demographics and inflationary pressures. In the 1970s, the Baby Boomer generation entering the labor market led to a surge in demand but curbed wages, contributing to double-digit inflation. Contrastingly, today's scenario showcases falling population growth propelling labor costs upward, while labor participation rates in the US hover at around 62%, altering the dynamics of inflationary trends.
During Arthur Burns' tenure as Chairman of the Federal Reserve, the complexities of addressing sticky inflation were evident as price levels remained elevated despite efforts to combat rising inflationary pressures. The challenge of navigating an economy plagued by sticky inflation limited the effectiveness of traditional monetary policy tools, leading to a protracted battle against escalating price levels.
Fast forward to the present day, Federal Reserve Chair Jerome Powell is confronted with a similar dilemma as inflation rates exhibit stickiness, resisting downward adjustments despite contractionary monetary policies. Powell's efforts to combat inflation by implementing measures like interest rate adjustments and tightening monetary policy mirror the challenges faced by predecessors such as Arthur Burns in managing stubborn inflationary trends. The shift in today's scenario isn't due to the surge in demand from the Baby Boomer generation but the contraction in the labour supply, which elevates labour costs and contributes to overall inflationary pressures.
This dynamic interplay between shifting demographics and economic forces underscores the complexities shaping our current economic landscape and highlights the ongoing challenges faced by policymakers in managing inflation in a changing world. Which the markets seem briskly unaware.
A very interesting comparison to make and appreciate the analysis! I wonder how much credibility of central banks has played a part now. Inflation did drop back quite a lot from the highs and inflation worries didn't really manifest themselves into the long run. Correct me if I'm wrong, but I assume in the 70s there wasn't as much belief in the long run inflationary trend.
Definitely, however, the very different labor demographics today have played a major role in many elements of the macro economy.
I think labour shortages compound this issue. The reality for Powell, he is on the road to being Arthur Burns.
This is the same debate we are haivng in Australia where real wages have been even slower to recover.
Thank you! There is no wage-price spiral in the current dynamic. Wages probably need to go up more to even catch up (on the lower-income end) with inflation that's occurred over the past few decades. This is probably the best way for them to go up, too: slowly and over time, and in a staggered natural increase pattern rather than all at once via federal law or regulation.
Yes - wages are definitely below the standard trend of 3.5% since the Great Recession in 2008 (the EPI has a good chart here - https://www.epi.org/nominal-wage-tracker/ ). It's slowly catching up and full employment or close to full employment is helping with that!
Great article!!!
Thank you! Glad you enjoyed it!
Because nothing "drives" inflation. Central banks control inflation.
https://thomaslhutcheson.substack.com/p/framework-for-monetary-policy-1
And no one knows how wages are behaving anyway because we do not have wage indices.
https://thomaslhutcheson.substack.com/p/wages-and-prices
And even in the sense that a shock to a price can induce the Fed to engineer above-target inflation to facilitate the adjustment of relative prices to the shock, "wages" is too heterogeneous to be the subject to such a shock.
https://thomaslhutcheson.substack.com/p/framework-for-monetary-policy-2?r=8ylpe&utm_campaign=post&utm_medium=web
I agree that a central bank can target any inflation and achieve that inflation in any given time period. Whether that is possible without large welfare costs (maybe if the central bank controlled both fiscal and monetary levels, but even then it is doubtful) is a separate question. Fundamentally, the central bank should maintain price stability while minimizing welfare cost (the central bank implicitly assumes a welfare function) - in the US, that's the implication of the dual mandate (it also appears like other central banks act in the same way even if they don't have the secondary mandate).
The proximate cause of moving out of equilibrium inflation is some form of shock - during the pandemic, it was the supply shock. Central bank responses should be different to different proximate causes of the inflation shock, if the aim is to minimize the welfare cost. The supply shock was large enough to affect basically an entire economy - whether goods via manufacturing shutdowns, port delays or services, via lockdowns. So although shocks to specific industries will be difficult for the central bank to address, a shock to a large section of it should be much 'easier' to address with the tools the central bank has.
I assume you mean by "price stability" a target inflation rate assumed to be consistent with maximum real income
Yes - to be more specific, instead of maximum real income, some form of maximization of a welfare function. Maximum real income is a specific objective function and I'm not sure that's necessarily the 'best' function to optimize on, given higher/lower inflation may also impact asset prices. This is where the subjective component of the Fed's remit kicks in.
OK the target inflation is chosen to maximize "welfare" not income. Could you give me an idea of what difference that would make in practice. [And I'll suggest one. :) Maybe "society" prefers an inflation target lower than the one that would maximize "income."] But asset prices?