Expectations of workers could help fuel cycle of inflation

Amitis Oskoui, a consultant who works mostly with nonprofits and philanthropies, has not had a wage increase since inflation began to noticeably eat away at her paycheck early this year. What she has had are job offers.

Oskoui, 36, has tried to leverage those prospects to argue for a raise as the rising cost of food, child care and life in general in California’s Orange County has cut into her family budget.

“Generally, in the past, it was taboo to say: I need it to survive, and I know what I’m worth on the market,” she said. “In this environment, I think it’s more acceptable. Inflation is so front of mind, and it’s a big part of the public conversation about the economy.”

That logic, reasonable at an individual level, is making the Federal Reserve nervous as it echoes across America.

When employees successfully push for raises to cover their cost of living, companies face higher wage bills. To offset those expenses, companies may lift prices, creating a cycle in which fast inflation today begets fast — and maybe even faster — inflation tomorrow.

So far, Fed officials do not think that wage growth has been a primary driver of America’s rapid inflation, Federal Reserved Chair Jerome Powell said Wednesday.

Fresh data out Friday showed that average hourly earnings climbed 4.7 percent over the past year. That is far faster than the 3 percent pace that prevailed before the pandemic and is so quick that it could make it difficult for inflation to fully fade. Plus, policymakers remain anxious that today’s pressures could yet turn into a spiral in which wages and prices chase each other higher.

If that happened, it could make inflation agonizingly difficult to stamp out — a major reason the Fed is adjusting its policy rapidly. Central bankers raised interest rates three-quarters of a point this week and signaled that they would lift them further in an effort to slow the economy and wrestle price increases down quickly enough to curb inflation expectations.

Some measures of short-term inflation expectations have picked up recently, meaning that people assume prices will continue to go up, at least for a while. That “may be important in the wage-setting process — there’s a school of thought that believes that,” Powell said this week. “So that’s very concerning.”

Economists typically focus on longer-term inflation expectations because short-term expectations jump around a lot in response to gas and food prices, which are volatile. Those longer-term measures offer more encouraging news: They remain low across a number of surveybased measures even after 18 months of rapid inflation.

But, as Powell alluded to, some economists think shortterm inflation expectations could influence what workers ask for during pay negotiations. When people see everyday prices rising, they may want to cover those expenses even if they believe that inflation will simmer down over the long run.

“With inflation as high as it is, it’s very much on people’s minds,” said Karen Dynan, a Harvard economist. When it comes to short-term expectations as a wage driver, she said, Powell is “right to be looking at it: There’s a fundamental logic to it.”

That’s why recent trends in short-term expectations are at least somewhat worrying. Since late summer, some measures of short-term inflation expectations have edged up, and even those that haven’t remain very elevated.

Part of the challenge is that nobody knows exactly when inflation will go from temporary to embedded. Economists do not understand inflation all that well: They regularly disagree about whether expectations matter at all, which ones are important and why. Models based on historical data may offer little guidance for today.

Given the uncertainties, the Fed is focused on bringing inflation down rapidly.

“The thing we need to do from a risk management standpoint is to use our tools forcefully but thoughtfully and get inflation under control, get it down to 2 percent, get it behind us,” Powell said.

While he does not think America is in a wage-price spiral, he said, that is no reason for complacency.

“Once you see it, you’re in trouble, so we don’t want to see it,” Powell said. “We want wages to go up. We just want them to go up at a level that’s sustainable and consistent with 2 percent inflation.”

The central bank will probably debate slowing its rate moves at its meeting in December, Powell said. But even as officials move at a moderate pace, they are likely to push borrowing costs up above the 4.6 percent level that they previously forecast, he suggested.