Wages and mon pol

We’ve viewed the recent run of stronger than expected inflation data with some surprise. Bumps in the road to be expected, sure, but it has sure felt like a lot of bumps.

You can have a few “beliefs” about how inflation forms. You can be Milton Friedman, calling it “always and everywhere a monetary phenomenon”.

You can take a socialist tac, and call it “profiteering”, from firm that price gouge (we don’t take this view).

You can take a labour market view, and believe the chain of causality goes from wages to prices (as opposed to the prices to wages view).

That idea is that wages drive spending, consumption is done out of income, and if wages are growing faster than the economy can produce you’ll get inflation.

Something like this; inflation = changes in firm markups + nominal wages growth – productivity growth. The firm markup is prices over cost, and cost here is assumed away as essentially labour. If wages are growing at 5%, and productivity is 1.5%, assuming no change in markups, inflation will run too hot at 3.5%.

And so, it’s important to see labour market data cooling. Wages, on a variety of different frames, do seem to moderating.

It also seems fair that if consumer prices rise faster than incomes, then you will get demand destruction, and people will cut back spending, which will have a deflationary effect over time. The economy does have “built-in” equilibrating mechanisms, even if they take a long time to play out.

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