Watching for a Wage-Price Spiral

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Rising inflation has more to do with the pandemic than labor costs. But it may change.

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It comes on the heels of Friday’s jobs report, which showed the unemployment rate fell to 3.9% last month, and average hourly earnings stood at 4.7%. The Federal Reserve is getting ready to raise rates as soon as March, and a combination of rising inflation and a tight labor market is causing it.

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What the Fed doesn’t want to see is an environment where wage increases are driving prices up significantly, while a tight labor market and high inflation expectations are pushing workers to reduce wage increases. This could keep inflation well above the central bank’s 2% target, forcing it to raise rates sharply and risk a recession.

To an extent, the rise in inflation over the past year reflects a rebound from the early stages of the pandemic, when prices fell significantly. Nevertheless, base prices have increased at a 3.3% annual rate over the past two years, the fastest pace since June 1993. This pickup is entirely a result of inflated commodity prices, while service price gains have been muted. Prices of key commodities have risen at an annual rate of 6.1% over the past two years, the highest since March 1983. The prices of core services have increased at a rate of 2.6% in the past two years, which is lower than in the two years before the pandemic. ,

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Goods—especially big-ticket goods like cars and appliances—are where supply problems are most pronounced. Freight has also been on the receiving end of the change in demand that the pandemic brought on: Unable or unwilling to spend money on services like airline tickets, Americans bought more goods instead.

Rising wages have certainly put some upward pressure on prices as well, but thus far they are largely secondary. If the pandemic loosens its grip, helping to ease supply-chain problems, while spurring spending back toward services, inflation will calm down.

How cold it will be is the big question. Rising labor costs can reveal how little the price advantage can be. Much will depend on whether more people return to the labor market after the Omicron-driven surge in Covid-19 cases ends, leading to ease of hiring. And much will depend on how successful companies will be in passing the burden of rising labor costs to their customers.

Tight job markets and high inflation may not feed each other now, but that doesn’t mean they won’t in the future.

Write Justin Lahart at [email protected]

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