Many central bankers have been trying various conditional narratives to convince us that their rate hikes are justified. Now they are effectively ignoring the information provided in the official data and simply making it up. Last Wednesday (May 17, 2023), the Governor of the Bank of England delivered a speech at the British Chambers of Commerce – Getting Inflation Back to the 2% Target – A Speech by Andrew BaileyA week earlier, the Bank of England raised bank interest rates by a further 25 percentage points to 4.5%. In that speech, he acknowledged that inflation is falling and key supply-side drivers are weakening. But he said the hike was justified and unemployment had to rise because there was now persistent inflationary pressure from a “wage-price spiral”. The problem with this claim is that there is no data to back it up.
Wage prices in the UK are spiraling upwards – sadly I can’t see it.
The Bank of England Governor told a chamber of commerce meeting that the UK was in an “exceptional situation” (Covid, etc.) and, like all countries, had suffered a “series of huge supply shocks”, including Covid restrictions on output falling activity and households shifting spending away from services (restricted) transfer to commodity.
This shift in 2020 and 2021 has prompted some economists to claim that inflation is a demand-side phenomenon that requires hard cuts in net government spending and interest rate hikes.
However, it has always been my position that when the contraction in supply is temporary and will resolve in due course, it is a rather odd structure of events to think that the proper remedy is to dampen demand – which leads to higher unemployment.
The last thing we should be doing is creating unemployment, because when governments suppress demand, either directly through fiscal policy or indirectly through monetary policy, unemployment tends to rise quickly and fall slowly, leaving individuals and communities with hardship and disadvantage.
The correct response is that of the Japanese government and monetary authorities.
Japan is subject to the same global supply constraints that drive up costs, but central bankers told us they have developed the view that supply pressures are temporary and have not justified an all-out attack with rate hikes that would jeopardize the country’s economy. low unemployment.
Cabinet agreed and used fiscal policy to provide some cash support to households to ease (temporary) cost of living pressures and some cash support to businesses as part of an agreement to keep profit margins in check and hold down price increases.
The result of this approach is that inflation has fallen to levels well below those seen in other developed countries, and unemployment remains low.
In any case it was a success.
It’s amazing how mainstream media ignores the “experiment” and just parodies the narratives of other central bankers.
I even heard an economist say on a major economics program on national ABC radio the other day that “central banks are raising interest rates everywhere”.
It was a lie and the reporter failed to recognize her.
Speaking to the Chamber of Commerce, the Bank of England Governor acknowledged:
…global supply pressures have eased.
Important to say the least.
He also said that rising energy costs due to the Ukraine situation “will now also be reversed”.
So, what is driving inflationary pressures in the UK?
Well, he claims the third:
…supply shocks have been domestic…
There we learn that Covid has caused a sharp decline in “workforce size” due to inactivity – mostly due to illness.
Latest labor market data from the Office for National Statistics (released 16 May 2023) – UK Labor Market Overview: May 2023 – whose revelations are rather shocking.
1. “Long-term illness and physical inactivity hit record highs.”
2. “In the three months to March, 2.55 million people were unable to work, accounting for more than 6% of the national labor force. This was an increase of nearly 100,000 from the previous quarter.” (source).
3. “The pandemic is likely to be one of the main reasons for the increase in the number of people with long-term illness over the past three years or so, including those with long-term COVID symptoms such as post-viral fatigue.”
4. “This is the largest number of people dropping out of the labor force due to long-term health problems we have ever seen”.
The reality is that our country will endure a large (and growing) number of workers permanently disabled by COVID-19.
The arrogance with which we are now in complete denial of the issue is astounding.
But the Premier was also astute to note that labor shortages that became acute in the early days of Covid were “reversing somewhat”.
Then there are “food prices”, partly due to “disruption of Ukrainian agricultural supplies to global markets”, which was the main cause of UK inflation last year (“Annual CPI inflation for food and non-food – UK alcoholic beverages from March 2022 5.9% rising to 19.1% in March 2023 latest figures”).
All these points are indisputable.
As he observes, inflation hurts the “least well-off” more because they spend more of their income on the most inflationary items.
But he didn’t back down from his argument that rate hikes are necessary – even if they hurt low-income households the most – “to bring inflation down”.
He noted that the loss of “real income” from increased imports of raw materials or products cannot be addressed through monetary policy.
So why are they raising rates?
His simple explanation is that banks have:
…take action to ensure that inflation falls as external shocks recede—inflationary impulses from these external sources do not have persistent “second-round” effects on domestic wage and price setting, keeping inflation in check for longer. That is why we have increased the Bank Rate by almost 4.5 percentage points from December 2021, from 0.1% then to 4.5% now.
Ah, the wage-price spiral—finally.
“The Dreaded Second Round Effect”.
He claimed that while inflation was falling as supply drivers weakened, there was a dangerous continuation due to these “second-round effects”.
what are these?
Well, he said the bank wanted the unemployment rate to rise (“shallow, long recession”), the problem was that this rise “has happened slower than we expected in February”.
In other words, they haven’t met their goal of pushing tens of thousands of workers out of work.
As a result, he claimed that the MPC:
… continue to judge that risks to inflation are clearly skewed to the upside, largely reflecting the likelihood of more persistent domestic wage and price setting.
As a result, we’ve moved from narratives such as those promoted by the RBA governor that they are “fearful” of a wage-price spiral to more explicit claims that inflation is now driven by the existence and operation of such a spiral.
This has become their reason for continuing to raise interest rates.
evidence?
Central bankers like to refer to their private briefings with the business sector and claim that at these meetings they learned about higher wage growth.
Initially, we were unable to refute these claims because we did not have enough official data which, if they did exist, would eventually reveal growing wage pressures.
But after more than 18 months of rising inflationary pressures, official data in the UK are still recording real wage cuts in a systematic manner, ruling out any wage-price spiral dynamics.
If we observed a leapfrogging pattern—a huge increase in nominal wages leading to an increase in real wages, followed by a spike in inflation the next quarter, etc.—then we might conclude that the differences between labor and capital over who bears the losses Distributional struggles increase real income due to higher import costs.
But it is difficult to frame the problem as an interactive wage-price spiral when real wage cuts are systemic.
Latest ONS wages data (released 16 May 2023) – UK Average Weekly Earnings: May 2023 – The day before the Governor’s speech indicated that:
Between January 2023 and March 2023, employees’ average gross wages (including bonuses) will increase by 5.8%, and regular wages (excluding bonuses) will increase by 6.7%.
However, here’s the important bit:
For the year January 2023 to March 2023, the real growth rates (adjusted for inflation) of total compensation and regular compensation are reduced by 3.0% for total compensation and 2.0% for regular compensation; In other words, a similar decline was seen in the first three months and remains the largest since comparable records began in 2001.
The chart below shows the annual growth rate of nominal and real average weekly earnings (gross wages) from the March quarter of 2001 to the March quarter of 2023 (latest available).
Pay attention to the dynamics.
The initial recovery in incomes after the lockdown period quickly gave way to a systemic loss of purchasing power as supply-side inflation subsided and nominal wages failed to keep up.
Workers have endured real pay cuts every quarter since mid-2022.
Even nominal wage inflation has been fairly stable since late last year.
Nominal wage growth has not accelerated over the past two quarters.
in conclusion
Remember, when inflation was just starting, the Governor of the Bank of England told British workers they had to cut their wages or he would put more people out of work, and he was already planning to do this by raising interest rates.
Well, they did take pay cuts, albeit involuntarily, and real wages have fallen systematically over the past year.
Now, the same governor is accusing workers of refusing to accept deeper cuts in real wages, creating an ongoing second-round wage-price spiral.
I know of all the economic models of spiraling wage prices—mainstream and otherwise—but no one would argue that this dynamic actually occurs and persists when systemic real wage losses occur.
There is no sign of any leapfrogging patterns in the UK.
Here’s another central banker who needs to lose his job.
Enough for today!
(c) Copyright 2023 William Mitchell. all rights reserved.
