Despite central bank worries, accelerating pay hasn’t fueled broader inflation in the past
In a supply and demand setting, an increase in the price of a resource (like labor, whose price is wages) causes supply to shift to the left (a decrease in supply). That raises the price of the good in question. If the demand curve is flat or only slopes downward slightly (so it is very elastic), then prices will not rise or will not rise very much.
The only way all of the rise in costs of production could be passed on to the consumers would be if demand is completely vertical (zero elasticity). That is true for very few, if any, products.
Excerpts:
"But some economists say the concern is misplaced. They say the lesson of the past few decades is that while higher prices lead to higher wages, as workers try to claw back lost purchasing power, the reverse isn’t true. If so, high wage growth won’t stand in the way of getting inflation down.
“I am concerned that this point may not be fully appreciated by some policy makers,” said Stefan Gerlach, chief economist at EFG Bank in Zurich. “Inflation and wages tend to move together, but that may be largely due to wages responding to past inflation, not inflation responding to past wages.”
Labor makes up the bulk of firms’ total costs in the U.S. and Europe. That means over time, rising wages should lead to higher prices, after adjusting for increases in workers’ output per hour. Otherwise workers would claim an ever-larger share of the economic pie at the expense of business owners.
In the U.S., hourly wages of private-sector workers were up 5.2% in August from a year earlier, a slower increase than 5.6% in July but much faster than around 3% before the pandemic. A different measure compiled by the Federal Reserve Bank of Atlanta, which isn’t affected by shifts in jobs between high- and low-paying industries, put wage growth at 6.7% in July and August, the fastest in at least a quarter-century. Both, however, are lagging behind consumer prices, which rose 8.3% in the year through August."
"But a variety of studies have found that over the past few decades, increases in labor costs haven’t been passed through fully or at all to prices."
"“The joint dynamics of inflation and compensation no longer manifest the type of wage—price spiral that was evident in earlier decades,” according to the 2017 paper."
"The shift likely reflects growing international trade and rising market power of businesses since the turn of the century, as well as a general decline in inflation, according to research.
The argument goes like this: As foreign competitors moved in, some domestic firms shut down. The firms that survive have higher profit margins, making it possible for them to at least partially absorb higher wages without passing them to their customers and avoid losing market share to foreign competitors." [If companies in these markets are oligopolists then there is a range over which a fall in costs does not lead to a fall in price for consumers, so the opposite is true, that a rise in costs will not increase the price consumers pay. See the link to the related post below and when you go to it just pretend that MC2 is MC1 and vice versa in the graph]
"Crucially, though, inflation was generally low and stable in the period these papers examined. If businesses now expect wages and other costs to rise strongly and persistently, they might be less willing to absorb them."
"Research published last month by the New York Fed found that before the Covid-19 pandemic, for goods and services that are traded internationally, wage increases didn’t filter through to prices at all. That changed in 2021, when a 10% increase in wages was associated with a 1.4% rise in producer prices.
Some companies are citing higher labor costs for why they are raising prices."
"businesses retain considerable market clout at a time of strong demand, economists say"
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