Post by Jack (from Oxford Analytica)
(Mar 24-hot news information) The combination of slowing growth and rising inflation has raised the specter of “stagflation,” a pernicious problem in the U.S. in the 1970s and early 1980s. Stagflation is puzzling to economists because slowing growth should mean weakening demand for labor, lower wage inflation, and softer product demand. This, in turn, should mean falling inflation–not rising inflation.
1980 Precedent
The year 1980 epitomized the stagflation process. Real GDP fell by a sharp 1.6%, meaning that a serious recession was taking place. The unemployment rate jumped to 7% in 1980 from 5.8% the year before. Yet on top of this economic weakness, consumer price index (CPI) inflation accelerated to 13.5% from 11.3% the year before.
Recently, similar trends in the data have renewed U.S. stagflation fears:
–CPI inflation was 4% in February; the annualized rate of inflation was 4.7% over the previous six months–up from a 3.5% annual rate of inflation in the six months ending August 2007, and the 2.6% year-on-year rate of inflation as of December 2006.
–The unemployment rate has crept upward, from 4.5% in May 2007 to 4.8% in last month.
–The pace of job creation has eased sharply from 175,000 net new jobs per month in 2006 to 107,000 jobs per month in the first half of 2007 to 76,000 jobs per month in the second half of 2007. In January and February of this year, an average of 43,000 jobs per month were lost.
–Meanwhile, commodity prices have soared. The price of gold has recently breached the $1,000-per-ounce mark–up from around $650 in January 2007. Oil prices have broken $100 per barrel barrier and the Goldman Sachs commodity price index has recently surged to an all-time high.
Overblown Fears
Any assessment of the prospects for stagflation depends heavily on a theoretical understanding of the inflation process. Some economists believe that price shocks–like oil surges and rising food prices–can boost underlying inflation. However, most say that inflation spikes rarely become persistent if higher prices do not become embedded in workers’ wages. Accepting this latter view, there are reasons to believe the current surge in inflation may be temporary.
Wages Contained
For all workers, total compensation was up 3% in the 12 months ending December 2007–less than the 3.1% increase in the 12 months ending September 2007.
Absent Danger Signal
The wage demands of the most technically sophisticated and skilled workers (those in management, professional and technical occupations) are a key indicator. When labor markets become tight and wage inflation starts to become a problem, it is the wages of these workers that show inflationary trends first, before the population at large.
To date, there is no evidence that the wages of highly skilled workers are accelerating. In the 12 months ending December 2007, total compensation for these workers was up 3.2%–less than the 3.4% increase experienced in the 12 months ending September 2007 or the 3.5% increase they enjoyed in the 12 months ending December 2006.
Productivity
Combined with the 1.6% annual productivity gains for the economy in 2007, these wage patterns suggest an underlying, annual “inflation impulse” into the U.S. economy of just 1.5% per year (roughly 3% wage gains, less 1.6% productivity gains).
Changed Labor Market
Another key difference between the current period and the late 1970s and early 1980s is that labor markets have changed dramatically:
–Union Decline. In the earlier period, unions represented approximately 20% of the labor force, and were often successful in pressing for higher wages, even in the face of slowing economic conditions. Just 12.1% of U.S. workers are currently members of unions, and union bargaining power has been significantly reduced.
–Few COLAs. A related factor is that cost-of-living adjustments (COLAs) were a feature of labor markets in the late 1970s and early 1980s, when approximately 60% of union workers enjoyed COLA benefits. These COLA provisions made inflation difficult to combat, because it quickly worked its way into wages, which had subsequent effects on future inflation. Today, few workers have COLA clauses in their contracts, meaning that there are few automatic links between inflation and wages.
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Oxford Analytica is an independent strategic-consulting firm drawing on a network of more than 1,000 scholar experts at Oxford and other leading universities and research institutions around the world. For more information, please visit oxan.com.