Monetary Policy & Inflation | US
This article is only available to Macro Hive subscribers. Sign-up to receive world-class macro analysis with a daily curated newsletter, podcast, original content from award-winning researchers, cross market strategy, equity insights, trade ideas, crypto flow frameworks, academic paper summaries, explanation and analysis of market-moving events, community investor chat room, and more.
In its just-published quarterly review, the BIS highlights that labour markets across advanced economies remain tight and explains why this has not yet but could lead to higher inflation in the future.
The BIS notes unemployment rates remain at past-decade lows across all AES, reflecting demand and supply factors.
Slower growth in labour supply caused by:
- Demographics.
- Change in work/life balance preferences, especially preference for fewer hours worked and early retirements. I think the triggers for this in the US were the pandemic lockdowns and high replacement ratios of government benefits.
Faster growth in labour demand than implied by GDP growth, caused by labour hoarding:
- Firms could not hire enough workers during the pandemic and remain wary of having too few of them.
- Firms are still struggling to find new workers, as shown by the long-term shift in vacancies relative to unemployment (Beveridge curve).
I think the BIS is missing out that, in the US, the strong demand for labour reflects that most of the increase in productivity since the pandemic has been captured by firms. This is shown by profits per workers, which jumped during the pandemic (Chart 1). In other words, hiring new workers is the most profitable it has ever been.
This is consistent with large firms benefitting from pandemic policies more than small firms, as shown for instance by the weaker recovery in RTY earnings relative to SPX, as well as with profits benefiting from government deficit more than worker income (see, for instance, GMO’s James Montier on Kalecki’s equation).
The BIS goes on to discuss why, despite the historically tight labour market, real wage growth has been negative in many countries. In the US, the Q3 ECI relative to PCE inflation is still about 1% below end-2019. The BIS sees four key explanations:
- The surge in inflation was unexpected.
- Labor markets setups reflect decades of low inflation, for instance wage contracts last multiple years. In the US, union density has been falling for decades.
- Central banks helped stabilize inflation expectations.
- Workers have been trading flexible work arrangements, including WFH, for higher pay.
I think all those apply to the US together with the decline in energy prices. It is very unusual to have energy prices fall when labour markets are tight, which is yet another peculiarity of the pandemic and its aftermath.
The BIS’s conclusion is that there is a risk labour markets could remain tight, which could see workers’ bargaining power increase, wage growth pick up and the passthrough between wages and prices strengthen. In that sense inflation is more dormant than vanquished. I agree 100%.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)