Monday, July 15, 2024

Your salary increases are still too rapid

Central bankers around the world are making progress in the fight against inflation. After reaching a peak of 10.7% in October 2022, inflation has fallen to 5.4% year on year. Although this is a significant achievement, the final push to bring inflation closer to the central banks’ target of around 2% is proving to be the most challenging part of the journey. This is primarily due to the lack of cooperation in labor markets, leading to rising wage growth and subsequently contributing to higher prices for consumers.

In the recent past, employers were struggling to find enough workers to fill open positions, resulting in a record number of unfilled vacancies. This surge in demand for labor led to a substantial increase in wages, with year-on-year wage growth doubling from its pre-pandemic rate to nearly 5%. As a result, companies were forced to increase prices to cover rising costs.

In order to bring inflation back under control, it was essential for wage growth to decrease. However, with weak productivity growth across the world, achieving a 2% inflation target would require nominal wages to grow by 3% annually or less. Central bankers hoped that by increasing interest rates, they could reduce the demand for labor, ultimately bringing down wage inflation without significantly impacting people’s livelihoods.

The initial phase of this plan has been successful, with the demand for labor now only slightly higher than the supply in the rich world. Furthermore, a decline in searches for “labor shortage” and fewer “help wanted” signs suggest that the labor market is gradually stabilizing.

Despite this, evidence of a decrease in wage inflation is minimal. While American wage growth has decreased to about 4.5% year on year, it is still higher than the Federal Reserve’s 2% inflation target. In many parts of the world, wage growth remains around 5% year on year, with some countries, such as the UK, experiencing even higher growth.

The possibility of high wage growth becoming a long-term issue is a concern, particularly in Europe. Workers’ increasing bargaining power has led to changes in contracts, resulting in higher wage growth and the potential for more persistent inflation. Strikes and industrial action have also become more common as workers demand higher wages.

Despite the challenges, there is optimism that, just like the acceleration in wage growth took time to materialize, the deceleration may also be slow to manifest. It takes time for companies and workers to renegotiate wages, with the effects of declines in labor demand possibly taking a year or more to be reflected in lower wage growth.

Overall, the journey to achieve lower inflation may be slow, but there is hope that it will eventually come to pass.

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