Gas prices grow along with inflation as this sign at a gas station shows in Carlsbad, California, November, 9, 2021.
Mike Blake | Reuters
What looked like a big jump in workers’ wages during October turned into just another gut punch after accounting for inflation.
The Labor Department reported Friday that average hourly earnings increased 0.4% in October, about in line with estimates. That was the good news.
However, the department reported Wednesday that top-line inflation for the month increased 0.9%, far more than what had been expected. That was the bad news – very bad news, in fact.
That’s because it meant that all told, real average hourly earnings when accounting for inflation, actually decreased 0.5% for the month. So an apparent solid paycheck increase actually turned into a decrease, and another setback for workers still struggling to shake off the effects of the Covid pandemic.
“For now, inflation is going to continue to run above very solid wage growth,” said Joseph LaVorgna, chief economist for the Americas at Natixis and former chief economist for the National Economic Council during the Trump administration. “This is why when you look at consumer confidence, it’s really taking a beating. Households do not like the inflation story, and rightly so.”
Indeed, while consumer confidence leaped higher from the lows of the pandemic around April 2020 for a solid year after, it has come down substantially since, coinciding with the rise of inflation to its highest pace in more than 30 years. The University of Michigan’s closely watched index of consumer sentiment for August slumped to around its lowest level in nearly a decade.
Wages, though, have swelled during the period, with average hourly earnings up 4.9% year over year in October. However, compared with inflation, real hourly wages actually have declined more than 1.2% during the same time frame, according to the Labor Department.
Real weekly earnings have been even worse, dropping 1.6% during the period when accounting for the 0.3% decrease in the average workweek.
Consumers have responded by ramping up their inflation expectations, which historically have been tied closely to gasoline prices. Costs at the pump have swelled 49.6% over the past 12 months, the Labor Department reported in Wednesday’s consumer price index reading.
The New York Federal Reserve’s most recent survey of inflation expectations, released Monday, indicated that consumers expect inflation to run at a 5.7% pace over a one-year horizon, the highest ever for a data set that goes back to June 2013.
“That means there is a potential structural break in inflation expectations,” LaVorgna said. “Unless there is a collapse in growth where you have a recession, we could be entering a new inflation regime.”
Either way, the Fed finds itself under increasing pressure to adjust policy accordingly. Central banks raise interest rates to combat inflation, though officials have said repeatedly they don’t anticipate doing so until at least well into 2022.
While central bank officials mostly insist that inflation will abate over the next year or so as conditions unique to the pandemic subside, the data pattern shows the Fed has underestimated price pressures.
Supply chain issues probably “will ease markedly over the next year and do not require a monetary policy response,” said Ian Shepherdson, chief economist at Pantheon Macroeconomics.
“But the Fed is now putting a great deal of faith in the idea the wages soon will be constrained by rebounding participation, and that stronger productivity growth will hold down unit labor costs growth too,” Shepherdson added in a note. “This is entirely reasonable, but not certain, and in the meantime core CPI inflation is going to rise further; the October print is not a fluke.”
Almost all economists join Fed policymakers in believing that the current inflation run bears little resemblance to the pernicious stagflation – high inflation, low growth – of the 1970s and early ’80s. However, there is some similarity, at least in that inflation cycles usually feel good in the beginning as wages are increasing but eventually become problematic when pay can’t keep up with rising prices.
The Fed has insisted on characterizing the current inflation run as “transitory,” even with the consistent increases.
“The risk that they cannot hold the ‘transitory’ line is rising,” Shepherdson wrote. “We remain baffled as to why Chair Powell chose not to warn markets explicitly of the risk of a run of big increases in the core CPI over the next few months; the components which drove up the October reading were all foreseeable.”
The question ahead is how long the current space of inflation will last, and Shepherdson said he expects core inflation, now around 4.6% year over year, to top out over 6% and run that high through March, “massively increasing the pressure on Chair Powell and other Fed doves.”
LaVorgna said he also expects some relief next year, but not without inflation running around 6% for several more months.
“I’m optimistic you’ll see some moderation in inflation, which means you’ll see real wages back in positive territory by the back half of next year,” he said. “But inflation will remain uncomfortably high.”
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