Do We Have To Cut Wages To Cool Inflation?

Addressing the sensitive topic of high inflation in May this year, Bank of England governor Andrew Bailey said the root of the problem was a wage-price spiral. What he meant was that, since workers’ wages had climbed, companies had been forced to hike their product prices to keep up the same earnings, and this had heated up inflation. The argument is not a new one, and often goes on to explain that, since pushing up wages is an unnatural interference in the labour market, it distorts the dynamics that would normally keep the economy in order.

In a recent interview, British Prime Minister Rishi Sunak proposed this view as if it were common sense, urging workers in the public sector to refrain from asking for wage increases since the result would be to bump up prices even more. Over in the U.S.A, the Federal Reserve has justified its campaign of interest rate hikes for the past year-and-a-half with the same logic: Higher borrowing costs are needed to convince companies to hold back on wage spending, so that demand will be dampened enough to hold prices down. The Cleveland Fed say that getting inflation down to 2% by the end of 2025 would necessitate a “deep recession" that would double the unemployment rate.

Policymakers are freely voicing their view that wages and employment must be sacrificed to heal the world of inflation, but many people beg to differ. Skanda Amarnath of Employ America, for one, says quite plainly that anyone who believes wage growth is the guilty factor behind inflation is suffering from a “failure of imagination”. Today, for the benefit of your overall CFD stock trading prowess, we ask: Might it really be true, as the policymakers say, that higher wages translate into inflationary pressure, or do their critics have a point?

Company Earnings

Christine Lagarde, chief of the European Central Bank (ECB), identifies hiked corporate earnings as the guiltiest factor in pushing up prices in 2022. Along similar lines, the International Monetary Fund (IMF) concludes that “Rising corporate profits account for almost half the increase in Europe’s inflation over the past two years as companies increased prices by more than spiking costs of imported energy”. According to this important view, it’s not the fact that companies have to compensate for paying higher wages that’s driving prices up, but, rather, their anxiousness to rake in more cash from consumers. Fed chief Jerome Powell has actually admitted that “I don’t think wages are the principal story for why prices are going up”.

Who to Blame?

If so, then what really is causing prices to keep rising, to the distress of consumers on both sides of the Atlantic? Powell believes the blame lies with Covid-19, clogged-up supply chains, and the conflict in Ukraine. Josh Bivens of the Economic Policy Institute elaborates that our particular economic circumstances are unique due to “the unexpected and weird shocks we’ve had over the last couple of years”. For this reason, naming wages as the cause of the problem is misguided, since they “are no guide at all” in our case. Bivens’ research confirms Lagarde’s and concludes that one-third of the price increases in the U.S. in the last quarter of 2022 can be put down to inflated corporate inflows. The proportion in the same period in 2021 was even higher at over one-half.

Summing Up

There’s plenty of other data supporting Lagarde’s explanation and, in fact, the empirical evidence gathered in recent years by researchers overwhelmingly supports her (and Powell’s) view that wage growth is innocent of the crime of stoking inflation.

Some other ways people have suggested to cool inflation, besides cutting wages, include trimming company earnings and improving efficiency in various ways. A 1990 study, for instance, reported that, when employees are happy with the pay they receive, they tend to work with more energy and morale.
Why, then, does the Fed insist on pursuing its path of hiking rates to cool inflation? KPMG’s Diane Swonk explains that the Fed has an official function to fulfill, which is to ensure a speedy return of prices to manageable levels, and this will determine their mindset in this regard, to a certain extent.