Inflation surprise: Wage gains eclipse price spikes

The war on inflation may be far from over, but the economy has reached a key, little-noticed milestone: Workers’ wage gains are finally outpacing the rise in consumer prices.

Americans’ average income has beaten inflation for the past six months, driven by the plummeting cost of gas, along with drops in furniture, cars and other goods. If the trend continues, it could be a boost for President Joe Biden as he gears up for a tough reelection campaign, undercutting one of the main Republican arguments against his handling of the economy.

“People really know how far their paycheck goes,” Jared Bernstein, a member of Biden’s Council of Economic Advisers, said in an interview. “When gas prices are down $1.70 relative to where they were last summer, that’s the kind of breathing room that people recognize.”

Yet that progress could be in jeopardy:As Federal Reserve officials prepare to meet next week to raise interest rates again, their inflation-fighting crusade — which Fed Chair Jerome Powell has vowed to continue — has sparked fears of a recession, meaning that workers could be forced to give up those hard-fought gains.

The economy added 4.5 million jobs in 2022, and data to be released on Thursday is expected to show that GDP increased by an annualized 2.8 percent in the last three months of the year, defying downturn worries for the time being. But that may change since the impact of the Fed’s aggressive rate hikes has not yet been fully felt in the economy.

Bernstein acknowledged the difficulty ahead. “A key part of our message is we’ve got more work to do,” he said.

Prices have been cooling for the past six months. The consumer price index rose 6.5 percent across all of last year, down from 9.1 percent for the 12 months ending in June. Average hourly earnings grew more slowly — 4.6 percent — over that time period. But a steady drop in inflation in the second half of the year helped income surpass price increases, bringing real worker pay roughly to the same level it was prior to the pandemic.

With unemployment still at modern lows, some in Washington and on Wall Street have held out hope that price spikes can cool further. Indeed, Wall Street investors expect the Fed to scale back the size of the rate hikes at its Feb. 1 meeting and beyond, partly because of the progress on inflation.

Prices have come down in many areas, but it’s the cost of gas that has drawn the most attention. That’s partly because White House officials have driven home the price declines for months by touting them on Twitter and in speeches — though the price is driven by global factors that are mostly outside of Biden’s control.

“When we did start to see gas prices go down, it did correspond to a period of increasing support for Biden,” Democratic pollster Carly Cooperman said, pointing to the party’s better-than-expected results in the midterm elections.

Still, she said, inflation has to recede a lot more for Biden to reap the full political benefit. “As long as voters find that their cost of living is expensive, it’s going to be hard to convince [them] there’s real improvement,” she said.

Workers will bear the brunt of any miscalculation by the Fed — whether it’s the central bank failing to sufficiently tame prices or hitting the brakes on the economy too hard. There’s also a danger that stronger wages themselves will stoke broader inflation, leading to even higher interest rates and perhaps a deeper economic slump in the coming years.

Income gains have been fed by a labor market with a shortage of workers, giving people more leverage to seek higher pay, particularly when switching jobs. Powell is closely watching inflation in core services industries where paychecks are often businesses’ largest expense.

“Inflation is coming down faster than we may have expected based on wage growth alone, but that’s unsurprising, given that inflation was driven up by factors that weren’t driven by wage growth,” said Daniel Zhao, lead economist on Glassdoor’s economic research team.

New research that has garnered attention within the administration as well as among top commentators in the field suggests there’s still a way this could end well.

In a draft paper, economists Guido Lorenzoni and Iván Werning found that, in the wake of an economic shock, inflation-adjusted wages might drop at first but then begin to rise as part of a normal recovery. That is, there’s room for workers to increase their take-home pay without it being worrisome to the Fed.

“You get a shock that makes the price of, say, energy inputs or microchips or lumber more expensive,” said Lorenzoni, a professor at the University of Chicago Booth School of Business. “Firms are faster to move, so they start raising prices. Workers catch up a little slower, so at the beginning, the [inflation-adjusted] wage goes down. But then workers keep catching up. At some point, firms are happy because the shock goes away. Then workers catch up.”

“If that’s the story, it kind of fits the data because it looks like real wages originally fell, now they’re recovering,” he said. “The important thing is, that is not a signal that things are completely out of whack.”

Fed officials aren’t yet convinced, worrying that the rapid increase in wages will keep inflation from going all the way back down to their 2 percent target, though wage growth has already showed signs of deceleration.

“It seems likely that returning inflation to 2 percent will require wage growth to slow substantially,” Dallas Fed President Lorie Logan said in a speech last week.

For the time being, Biden is touting the income gains. Non-supervisory workers have slightly higher incomes than they had before the pandemic, and people with low-paying jobs have fared better than their higher-earning counterparts, as restaurants, hotels, and warehouses compete for a finite pool of employees.

“It all adds up to a real break for consumers,” Biden said earlier this month.

----------------------------------------

By: Victoria Guida
Title: Inflation surprise: Wage gains eclipse price spikes
Sourced From: www.politico.com/news/2023/01/25/inflation-wage-gains-eclipse-price-spikes-00079284
Published Date: Wed, 25 Jan 2023 04:30:00 EST

Read More