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Increasing Wages are the Elephant in the Inflation Room

Countries across the globe have witnessed dramatic inflation in the last year, especially in recent months. The annual rate of producer-price inflation has stayed close to 10% in the EU and the US. Moreover, the threat of a Russian invasion of Ukraine has caused oil prices to spike to more than 96 USD per barrel, heights that have been witnessed since 2014, which has, in turn, caused spikes in costs throughout the supply chain. There are a lot of reasons to believe that prices will continue to rise, and one thing that no politician wants to admit is that it might have a lot to do with increased wages.

America’s annual wage growth of 5.7% is “plainly inconsistent with the Federal Reserve’s 2% inflation target” according to The Economist. President Biden is touting this wage growth as a win, while his political opponents are blaming him for rising gasoline prices. Across Biden’s Party, many Democrats are pointing out how corporations are seeing record profits, and, therefore, painting rising prices as mere corporate greed, not the consequences of macroeconomic trends. Similarly, in the EU, Christine Lagarde, the head of the European Central Bank, has indicated that she hopes to see wages rise, yet many of her colleagues warn that there are dangers of excessive pay growth. Andrew Bailey, the governor of the Bank of England, has directly called for workers to rein in their demands for higher wages.

Who Really Pays

The typical wage-price spiral goes like this: when workers receive a wage hike, they demand more goods and services and this, in turn, causes prices to rise. Prices rise because higher pay pushes up costs for companies, which then increase prices to protect their profits. In the end, this spiral ends up hurting workers the most. In every G7 country, inflation has been higher than wage growth over the last year. That is, the prices workers have to pay are outpacing the money they are taking home every month. In Europe, the main cause for high inflation is expensive energy and the resulting supply chain cost increases. It’s more complicated in the US, where inflation is a consequence of spending, mid-pandemic stimulus checks, and low interest rates. Therefore, companies have raised prices not only to pass on costs, but to mitigate demand. In such a situation, companies with capital have the power, not labour, especially since workers/unions have significantly less strength than they did in decades past.

To stop the spiral, experts say that the only real path is an adjustment to macroeconomic policy. Attempts by countries to get workers to demand less (like they have in England), or for companies to pay more (like they have in Japan), are not going to solve the problem. Instead, direct adjustments to real levers of power need to be made: all signs point to the need for governments to raise interest rates. The longer it takes for governments to adjust, the more painful it will be to get inflation back to reasonable levels.