Wednesday, October 8, 2014

Wages, inflation and interest rate rises | Slack in the economy is an issue on both sides of the Atlantic

There was a time when wage demands were the bugbear of central banks and politicians. That was when they were battling spiralling inflation with all its problems for a stable economy. Rapid price increases created demands for higher wages to compensate for lowered buying power, which meant that employers had to increase prices in turn to remain viable, which led to …more inflation.

Now the boot is well and truly on the other foot. On both sides of the Atlantic, in Washington and London, the powers that decide when and if interest rates are to rise are no longer focused on employment figures but rather on the rates of pay for those citizens who have jobs.

This fact was borne out by the minutes of the last FOMC meeting, which were released last evening in GMT terms, where the desire of the committee members to signal a timetable for an increase in rates is bedevilled by the worry about slack in the economy, characterised by the low level of wages and wages growth that have accompanied concrete decreases in the unemployment figures.

This is an excerpt from the minutes:

Several participants commented that the relatively subdued rise in nominal labor compensation was still below longer-run trend rates of productivity growth and inflation and was a signal of slack remaining in the labor market”.

It is not straightforward, however. Here is more:

“a couple of others suggested some caution in reading subdued wage inflation as an indicator of labor market underutilization”.

So. You pays your money and you takes your choice.

Slack in the economy is an issue on both sides of the Atlantic

Over in the UK, Mark Carney, governor of the Bank of England, is on record as saying that even when adjusted for inflation (emphasis added), wage rates are some 10% lower than they were before the Global Financial Crisis. He claims that one would have to go back to the 1920s to find a comparable situation.

Low average wages are taken to mean that large numbers of people are just making do with jobs that they are not really interested in. This is an unsustainable situation and one that does not give central bankers the confidence to believe that their economies are out of the recessionary woods just yet.

Later today we will have the Bank of England (BoE) Monetary Policy Committee decisions on interest rates and the Asset Purchase Facility. No doubt Mr. Carney and his colleagues will bring us up to speed on the latest deliberations on this issue of slow wage growth allied to falling inflation, and their implications for interest rates.

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