The wild card in the Feds inflation gambit: Morning Brief – Yahoo Finance

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Monday, June 28, 2021

Does anyone remember the word quiescent?

Its an economic catchphrase popularized by Alan Greenspan, the former Federal Reserve chairman who presided over an impressive run of strong growth and stable inflation.

During his lengthy tenure, the central banking minence grise invoked quiescent to describe stable prices mostly attributed to a mix of technology, high productivity and globalization in the face of comparatively strong growth. He was also notoriously hawkish on wage-driven inflation (his broadsides against minimum wage hikes earned him the enmity of left-leaning economists).

With price pressures percolating everywhere, one wonders what the now-nonagenarian must think about the current economy and Fed policy, particularly in light of an acute worker shortage thats prompting employers to hike wages.

On Friday, some data shed light on a dynamic that could complicate the Feds delicate act of navigating the Scylla of a scarred labor market, and the Charybdis of rising prices. Namely, workers are (finally) reaping bigger paychecks.

Mays personal consumption figures were largely in-line with expectations, but showed wages and salaries posting another consecutive month of gains. Separately, the University of Michigan's Consumer Sentiment Index dipped in June, but 32% of survey respondents in the top third income bracket saw their pay rise and a small number expect to earn even more in the year ahead.

Workers have seen an uninterrupted string of higher paychecks over the last year, albeit some months leaner than others.

A defining characteristic of the post-pandemic labor market is that workers have, to some extent, recouped lost bargaining power. For better or worse, workers are holding out for fatter paychecks, demanding more flexible work arrangements or just quitting their jobs altogether.

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Previously, the worker did not have that ability to command higher wages ... because we didn't have much in the way of broader inflation, Kevin Flanagan, head of fixed income strategy at WisdomTree, explained to Yahoo Finance in a recent interview.

Now were looking at a broader swath of when consumers have to pay more [and] now you can see the changing dynamic of workers trying to command higher wages, he said. And thats the concern: If you start throwing wages into this mix, then the Fed will have an inflation problem.

On one hand, higher pay is welcome news to cash-strapped workers. For years, stagnant wages amplified the searing debate over wage inequality, and were mostly responsible for eroding support for globalization and free trade two of Greenspan's economic shibboleths.

Yet as Harvard economist N. Gregory Mankiw once pointed out: When expected inflation is high, workers demand larger wage increases. Employers acquiesce, expecting that they can pass higher costs on to consumers. As a result, high expected inflation leads to rapid cost escalation, which in turn leads to high actual inflation.

The coiled spring of pent-up demand is sending prices everywhere on a tear (even wings and chicken sandwiches haven't been spared). With ample evidence suggesting that companies are hiking prices as the economy booms, consumers are literally eating higher wages and supply costs. Theres simply no telling when or how it will end.

All of which suggests the Feds gambit is flying in the face of the anti-inflation doctrine inculcated by Paul Volcker, Greenspans predecessor and the man credited with slaying the dragon of double-digit inflation. Fast forward several decades, and some Wall Street economists are calling out the Fed for being asleep at the wheel on soaring prices.

The Fed maintains that their policy is somehow creating jobs, but higher prices are a tax on the wages of job holders and a heavy price to pay for everybody, veteran market analyst Chris Rupkey wrote last week.

The two-handed Fed stimulus giveth and taketh away. The good news is you have a job, the bad news is your paycheck doesnt buy a darn thing, he added.

To sum it up, inflation is quiescent no longer. At some point, Fed Chair Jerome Powell will need to muster his inner Volcker in an attempt to unleash the animal spirits of the economy while restraining the beast of inflation.

But as any casual Game of Thrones watcher knows, unless your last name is Targaryen, you should never attempt to tame a dragon. It usually doesnt end well.

By Javier David, an editor for Yahoo Finance, is filling in for Myles Udland, who will return tomorrow. Follow him on Twitter: @Teflongeek

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The wild card in the Feds inflation gambit: Morning Brief - Yahoo Finance