Many assume rising interest rates are inevitable, but if you’re trying to get a feel for the Fed’s timeline for raising the overnight interest rate, history would encourage keeping an eye on inflation uptick. In the past, wage increases have sparked inflation, but is this still the case today?
The Fed’s authority over the nation’s currency comes with a mandate to control inflation, and the Fed’s official goal is to maintain an annual 2 percent rate of inflation. That’s a lot easier said than done. It’s not a simple matter of creating reserves. Rather, as the Japanese and now the European experiences have underscored, it requires a robust demand to re-employ idle resources.
The transformation of the nation’s labor markets has added to the challenge. Over the past few years, worker productivity continued to grow while wages stagnated. This imbalance led to an increased supply of real goods, without the needed consumer spending power to drive economic growth—which in turn, limited inflation. Instead of boosting wages, our national productivity gains have pushed corporate profits to nearly double their historic average—post-tax corporate profits currently amount to more than 10 percent of GDP, but have also kept active economic growth in-check.
Historically, higher productivity is usually accompanied by rising wages, but persistent unemployment and emerging economies have led to elevated saving—causing this relationship to falter. Why? Labor markets have become very competitive. For more than a century, unionized workforces exerted strong bargaining power to maintain higher wages—leading to higher productivity being correlated to hiring increases as well. This was especially true in the manufacturing sector, where higher wages often drove inflation, which in turn allowed for higher retail prices.
It was common in those days for wage developments to force businesses to raise prices, leading to the popular idea of cost-push inflation. Those days are long gone, however, with the causality going the other way, from prices to wages. Those who believe that rising wages will be inflationary are remembering a labor market that no longer exists.