Why the increase in wages reduces inflation in the new economy

Contrary to popular belief, Rieder argues that wage growth does not lead to higher inflation, but may even have a moderating impact on inflation over time, which has important consequences on how to judge monetary policy today.

In recent weeks, there has been a sharp increase in volatility between asset classes and a massive sell off of most risky assets. It is impossible to determine the exact moment when the sentiment worsened, but the US employment report of 7 September, which revealed wage acceleration well above market expectations, may be at the origin. As a result, some comments by Federal Reserve decision-makers took a distinctly more hawkish tone, with some central bankers suddenly demanding gradual rate hikes to a destination potentially well above the perceived neutral rate.

Wage growth does not lead to inflation in the new economy

With fears of wage growth leading to higher inflation being deep-rooted, the business climate is showing a sharp decline for the Q3 earnings season, as increasing pressure on profit margins. much of which results from higher wages. While the Fed is not announcing the end of rate hikes and companies are revealing a potential end to the expansion of margins, risky assets have been under strong downward pressure in a very short period of time. Many market commentators have expressed confusion about the reasons for this sudden change, but for us, there is little ambiguity about what motivates it: markets scream that rising wages are largely responsible for the cyclical overheating of growth and inflationso that the gradual tightening of the Fed, combined with reduced profit margins, is too burdensome for growth. In the end, we think the FOMC will also take this view, which is why we believe the Fed will pause its rate hike cycle early next year.

Paradoxically, wage growth is not only not inflationary, it can actually have a moderating impact on growth and inflation in the current economy! Indeed, rising wages can be an organic impediment to future growth and inflation if firms hinder their expansion plans at higher costs; The same is true for higher interest rates for both businesses and consumers, even without a potentially damaging monetary policy. Moreover, and very importantly, even though the new pricing power of the workforce can reduce corporate profit margins and thus curb growth and inflation, the rise in wages is a healthy development for this cycle and should not be tempted by policy makers. reduce.

In fact, the pricing power of a company is not determined by the wage trajectory and the need to pass on these additional costs, but rather by the inherent environmental conditions that affect its overall business. Is it logical to conclude that a company would seek to increase its prices only if it were obliged to pay higher wages to its employees? If this were true, it would imply that – all things being equal – companies have hitherto proactively chosen to accept lower return on equity by not raising prices, which constitutes a clear breach of fiduciary responsibility to maximize shareholder profits. Companies are always looking to maximize prices and profits to create an optimal balance between market share and margins.

Pushing further, wage acceleration combined with rising input costs (trucking, construction, commodity prices, etc.) is beginning to impede the very cash flows that have been targeted to finance capital expenditures. intended to fuel future growth. In the end, these rising costs reduce a company's desire to hire more workers. As this dynamic broadens, aggregate demand falls, the economy slows, and ultimately, inflation declines. Thus, the balance can be restored by the capitalist forces and without the "help" of the decision makers. In fact, at this point, We believe that a rise in interest rates will only serve to further reduce corporate margins and accelerate the decline in spending, particularly in the most sensitive economic sectors. at interest ratessuch as housing, automobiles and small businesses. This is exactly what we observed with recent data and some stock market developments in these sectors. Markets are extremely concerned about the pernicious impact of this double threat on corporate profits and what this means for future growth (and inflation).

Rising wages and lowering the cost of goods serve the social need

Beyond the simple economic implications of rising wages, there are powerful and virtuous societal benefits that ultimately benefit American workers, which the Fed should seek to extend, not abbreviate. The combination of rising wages and falling property prices (driven by technological innovations) paves the way for an increase in household savings just as the financial needs of a growing basin are rising. Retirees are about to gain momentum and where the cost of a college education is becoming increasingly important – always more of a challenge. In fact, for the first time in a generation, consumer confidence among the lowest income groups is growing faster than that of the most affluent employees.

For most of the past decade, inequalities in wealth and income have been widely discussed. In addition, the share of worker profit margins reached record lows in the post-crisis period. For us, it is very ironic that after years of easy monetary policy that allowed these inequalities to widen under the effect of wealth, policymakers are now proactively attempting to thwart 39, the emergence of a broader wage increase that stimulates the growth of the standard of living in the United States. With almost all inflation indicators well maintained, the Fed's confused search for a "neutral policy", coupled with the vocal intent to become restrictive, is a political path without justification. Our advice to decision makers is to listen to the message of the markets. The increase in wages can lead to an organic tightening of financial conditions and a more positive influence on a large part of the population. In addition, we do not need a redundant policy reinforcement (further increases) that could reverse these nascent societal benefits.

This to post originally appeared on the BlackRock blog