cinternal bankers enter the last part. Prices in the rich world are rising at an annual rate of 5.4%, down from a peak of 10.7% in October 2022. While this is impressive progress, the final part of their quest – 5% inflation Getting .4% to official targets of around 2% – could be the hardest part. That’s because labor markets don’t work together.
Until recently, employers wanted to hire many more workers than they could find, resulting in an unprecedented increase in the number of unfilled positions (see chart). In 2022-2023, Google searches related to “labor shortage” rose to their highest level ever. With plenty of other options, employees asked for large pay increases. Year-on-year wage growth in the rich world doubled from pre-Covid levels to almost 5% (see chart), pushing up companies’ costs and in turn encouraging them to lower the prices they charge to consumers charged to increase.
To get inflation under control, wage growth had to come back down. Given weak productivity growth in the rich world, a 2% inflation target is likely only achievable if nominal wages rise at 3% per year or less. Central bankers hoped that by raising interest rates they would reduce demand for labor – ideally cooling wage inflation without destroying people’s livelihoods.
The first part of the plan succeeded. Labor demand (i.e. filled jobs plus open vacancies) is now only 0.4% higher than the supply of workers, down from 1.6%. Searches for ‘labor shortage’ have fallen by a third. You’re less likely to see ‘help wanted’ signs almost everywhere.
The lower demand for labor has also done surprisingly little damage to people’s employment prospects. We estimate that falling vacancies have accounted for most of the decline in labor demand in the rich world over the past year. Over the same period, the number of people actually working has increased. The unemployment rate in the rich world remains below 5%. Some countries are even breaking records. In Italy, the share of working-age people in jobs has recently reached a record high; the country has changed course the dolce vita for la laboriosa vita.
Nevertheless, despite falling labor demand, there is less evidence for the last part of the plan: lower wage inflation. While U.S. wage growth has fallen from more than 5.5% annualized to around 4.5%, that is still likely too high for the Federal Reserve’s 2% inflation target. And elsewhere there is little sign of progress. In recent quarters, annual wage growth in the rich world has hovered around 5%. British wage growth is over 6%. “Very early indications for January show only a modest delay in negotiated wage deals,” analysts at JPMorgan Chase said last week. Wages in the eurozone are also growing rapidly.
Is high wage growth, and therefore excess inflation, now baked into the economic pie? There are indications that this is the case, especially in Europe. For example, Spanish workers have used their extra bargaining power to change their contracts, so that the share of workers whose wages are indexed to inflation rose from 16% in 2014-2021 to 45% last year. A recent study by the OECDa club of mostly rich countries, about Belgium’s concerns about “more persistent inflation due to wage indexation”.
More generous wage deals today could mean higher inflation tomorrow, which in turn could lead to even more generous deals. Across the rich world, strikes have become more common as workers seek higher wages. Last year, America lost nearly 17 million workdays due to work stoppages, more than in the previous decade combined. Britain has also seen a wave of industrial action. On January 30, Aslef, a train drivers’ union, began a series of strikes, much to the dismay of commuters.
However, there is a more optimistic interpretation of these developments. Just like in 2021-2022, when wages took a while to start rising after labor demand rose, today they may take time to lose speed. After all, companies and employees rarely (often annually) renegotiate wages, which means that employees only slowly realize that they have less bargaining power than before. Estimates for the Americas published by Goldman Sachs, another bank, suggest that it could take about a year for the decline in labor demand to manifest itself in lower wage growth – suggesting that the final stretch of disinflation will be annoyingly slow, but it will pass. . ■
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