In a recent report, analysts at ING focused on Germany, where demand-side issues with inflation are becoming more of a problem. While stating that “greedflation” cannot be proven and that there are sector-specific variations, they wrote that there are indications that businesses have been raising prices ahead of increases in their input costs and that “from the second half of 2021 onward, a significant share of the increase in prices can be explained by higher corporate profits.” This is referred to as a profit-price spiral.
Klaas Knot, the head of the Dutch central bank, pushed businesses to boost salaries for employees in December and said that 5%-7% pay increases in industries that could afford them, together with government subsidies for energy costs, would help balance the impacts of inflation rather than fostering it.
The Leiden University’s Kristin Makszin, an assistant professor of political economics, concurs. While both salaries and prices are increasing, she told CNBC that we cannot overlook other forces that are causing both prices and incomes to rise, such as a tight labor market.
“Wages have not recovered since the Global Financial Crisis,” she remarked. According to Makszin, an annual salary rise of around 3.5% in the U.S. would be seen as favorable after accounting for 1.5% productivity growth, 2% inflation, and other factors.
“It’s not that a wage-price spiral couldn’t happen, but it’s low on the list of concerns versus the factors we know are problematic,” the speaker added. These include a possible downward low-wage-productivity cycle, in which productivity and subsequently economic growth are dampened when wages are insufficient to entice individuals back into the labor or to places where they are needed.
Workers’ negotiating power has been eroded since unions have less clout than they had in the 1970s, according to Makszin, which is a major mechanism that would feed a wage-price spiral.
People might simply refuse to work in a tight job market, she said, so politicians must address this issue. “Wages have increased dramatically in sectors like U.S. hospitality, but that was correcting for many decades of low-paying work when labor was replaceable… it could be viewed as compensating for long-term wage stagnation,” she noted.
Risk of stagflation
The U.K., according to Alberto Gallo, chief investment officer of Andromeda Capital Management, is the “most vulnerable developed market economy” in terms of a wage-price spiral.
According to data released this week, pay growth in the United Kingdom increased by 6.9% in the private sector and 5.3% in the public sector in the three months leading up to March 2023, which is less than predicted. Inflation is still over 10% and beyond the Bank of England’s objective of 2%.
It’s a worry that “even if the increase in wages will be absorbed by productivity gains, inflation expectations may rise and this could lead to a wage-price spiral,” according to a note from Gallo.
A phenomenon known as stagflation, in which inflation is high but economic development is weak or sluggish, is also being warned of by some analysts.
The IMF’s Gourinchas expressed worry that the recent price increase might lead to a “sort of vicious circle,” where consumers’ buying power is reduced and demand decreases, which then results in job losses and declining wages.
He said, “We haven’t seen this happen yet, but it is a risk.”
There is little doubt that policymakers are treading a fine line. They must assist employees who are dealing with growing costs while preventing an inflationary wage-price spiral. Additionally, there is increasing pressure on them to take action as inflation reaches multiyear highs.