2.4: Legacy

Low US wage inflation seems to be a legacy of the collapse in commodity prices. As with the new series of 24, a plot twist should inevitably provide redemption to inflation hawks. Wages should pick up in line with headline inflation as the oil effect fades.

The new series of 24: Legacy has just been released in the UK. As a fan of technology, thrillers and geopolitics, it’s one of my favourite shows.

 

You need to take a break between watching each series as it can be quite formulaic. There’s always an initial threat or crisis which the counter-terrorism unit slowly get under control. They close in on the culprit, which is typically someone from Russia or the Middle East. But then there’s always an unexpected plot twist, a change of direction.

 

The Russian/Middle Eastern bad guy is often a side show. The real danger lurks from within. The Vice President's spouse is often bored and has eyes on changing the curtains in the White House and so metaphorically stabs the president in the back.

 

There are new personnel in this series: Jack Bauer is no longer fighting crime. Back in the real world, we likewise have new officers in charge of monetary policy: special agent Yellen instead of Bernanke or Greenspan. But I’m sure the plot twists remain the same.

 

In particular, I think US wage inflation will change direction this year. I think the recent low wage inflation prints are a legacy from the previous collapse in oil prices. In 2014, Middle Eastern oil producers declared a price war on US shale producers in an attempt to regain market share. Cheaper petrol pushed US consumer-price inflation down towards zero. I believe this stalled the upward trend in US wage inflation.

 

The chart below shows that US wage inflation has been creeping higher since 2013, in response to falling unemployment. But it moved sideways in 2015.

 

This is a natural response to lower consumer-price inflation. When we model wages, we find the biggest driver is the tightness of the labour market: the number of unfilled job vacancies. But we also find significant effects from lagged inflation.

 

When consumer price inflation is zero, companies can get away with offering 2½% (call it 2.4) wage deals, as that still represents a chunky increase in living standards for workers. But with headline inflation now back above 2%, it will be harder to impose another modest wage deal.

 

So as the side show from oil (Middle East and Russia) fades away, the real driver of wage inflation will be revealed. It’s an internal issue: the shortage of workers (see recent blogs “Donald’s Difficult Demographics” and “Reservations about reserve workers”).

 

I believe low wage inflation is a legacy of the collapse in commodity prices and a plot twist will provide redemption to inflation hawks later in the year.

 

This blog is a summary of my recent Fundamentals “Labour market pains” which looked at second-round effects from lower commodity prices.

 
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