In this blog, NERI Co-director, Paul Mac Flynn discusses the release of last months inflation and wages data. On the face of it the results might have been encouraging, inflation fell once again and wages growth held steady. Unfortunately, this analysis doesn’t capture the full picture for a number of reasons.
As this cost of living crisis grinds on, there are many who are eager to see a light at the end of the tunnel. Too eager perhaps. The cause of this premature jubilation was the release of last months inflation and wages data. On the face of it the results might have been encouraging, inflation fell once again and wages growth held steady. This led many to pronounce that wages were now running ahead of inflation, or growing in real terms, and so the end of the crisis was near.
Unfortunately, this analysis doesn’t capture the full picture for a number of reasons. Firstly, when we’re talking about wages and inflation, we’re talking about the speed at which something is growing, we’re not talking about absolute levels. Secondly, we often tend to report wages and inflation in this month compared to the same month in the previous year. That can be problematic especially during a period of big economic shocks.
The best way to think about this is to imagine two people running in a race. The first runner sets off at cracking pace, while the second runner starts out much slower. Initially, this puts a large distance between the two, but as the race goes on, the second runner gradually begins to increase his pace, while the first runner begins to slacken off. There then comes a point where both runners are going at the same speed.
Now, at this point, while both runners might be going at the same speed, they’re not necessarily running alongside each other at the same point on the race. This depends on how much of a distance was put between the two runners at the start of the race. While the gap between them may have closed slightly, so long as they keep running at the same pace, the first runner is still going to win. Even if the second runner begins to outpace the first, it will all depend on how much of the gap he can close before the race ends.
This is how we should think about the cost of living crisis. Yes, it is positive that for last month at least, wage growth seemed to be outpacing the growth in prices, but the distance built up between the two means we still have some way to go.
To look at the latest figures, between July of this year and July of last year, median wages increased at a rate of 7.5% and prices increased by 6.8%. While superficially this looks good, it is an incomplete picture because it matters when the race began. In this case the shock of the energy crisis was felt in the early part of 2022, and therefore only looking back one year misses out on the main event.
If we extend out analysis back to January 2022, we can see a much different story. Over that period of time, wages grew by 8.7%, but prices during the same time grew by almost 14%. So, while wages may have managed to match the speed of prices in the last 12 months, there is still some distance to go before they can make up the ground they lost in the first 6 months of 2022.
While July’s figures were positive, there is no clear indication that we are at a turning point. Yes, inflation does appear to finally be coming down, but there is no guarantee that this will continue at pace. Secondly, and perhaps more worryingly, the path of wages over the last year has been erratic and there is no clear sign that wages are on an upward trajectory. When we look at monthly increases, there are actually indications that wage growth may already be slowing.
All of this may sound over sceptical, but when we look back over the last two decades of wages and prices, such caution is well founded. In the long race between wages and prices, wages have rarely made up the distance during previous economic shocks, whether it be the 2008 financial crisis or the fallout from Brexit.
Another reason for caution is that the race between wages and prices isn’t a fair fight. If there were some people who greeted last month’s pay figures with joy, another group of people received them with dread.
Central bankers see the growth in wages as a very unwelcome development. They believe that wages catching up to prices will only spur prices on further and that way lies chaos. In their minds, prices are always looking over their shoulder at wages and adjust their speed accordingly.
They believe that if they can trip up wages by raising interest rates, prices will not run as fast, and order can be restored. In reality, central banks lack the ability or the inclination to take action on prices themselves and that’s why they end up taking aim at wages.
The lesson here is that the race between wages and prices is long. Wages may be gaining on prices, but there is plenty of room for a last minute upset.