US figures next week will highlight a curiosity – that inflation is flat. The Bureau of Labor Statistics (BLS) is expected to say on Friday that 'core' CPI inflation (which excludes food and energy) is just 1.7 per cent, lower than last year. This is curious because economists used to believe that falling unemployment – and especially an unemployment rate below around 6 per cent – would lead to higher inflation. And yet inflation is absent despite an unemployment rate of just 4.4 per cent – close to a 16-year low.
Fed chair Janet Yellen has called this a “mystery”. As with all good mysteries, we have several suspects, some of whom seem to have alibis.
One possibility is that inflation is no longer set by the amount of slack in the domestic economy, but by global spare capacity. This, though, runs into two problems. One is that inflation in the eurozone has risen, albeit from a low level. Another is that economists believe that globalisation is only a small contributor to low US wages.
A second possibility is simply that people have confidence in the Fed’s ability and willingness to control inflation, and so haven’t raised prices – inflation expectations are self-fulfilling. Although inflation expectations, as measured by bond yields, have risen a little since 2016, they are no higher than they were in 2013-14.
Another is that demand is weak. In real terms, retail sales have grown by barely 1 per cent in the past 12 months despite high consumer confidence. This has caused a swathe of bankruptcies in the sector. Eventually, this might raise inflation by increasing the pricing power of surviving stores. In the meantime, though, retailers are holding prices down in a desperate effort to attract custom.
Yet another suspect is that there’s a lot of hidden unemployment. Official jobless figures hide the fact that millions have dropped out of the labour market; the employment population ratio is still well below its 1987-2007 average. And a wider measure of joblessness, which includes those not in the labourforce who want a job, is still above its pre-recession level.
There is, though, another possibility – that workers’ bargaining power has declined, so they are unable to parlay low unemployment into wage rises. This needn’t be because of the threat of immigration or low-wage imports. One corollary of the rise of monopoly power is that workers have less ability to get pay rises. As David Autor and colleagues at the Centre for Economic Performance show, the rise of the superstar firm has contributed to a decline in labour’s share of GDP.
In this sense, the “mystery” of low inflation forces us to remember what we knew in the 1970s and 1980s – that inflation was the result of conflict between wage- and price-setters. As Wendy Carlin and Sam Bowles say in their new online economics course at Core, “inflation arises from conflicts among economic actors, when they are powerful enough that their claims on goods and services are inconsistent”. From this perspective, if wage-setters lack power, there’ll be no inflation.
This does not mean the Fed won’t raise interest rates. There might come a point when workers do regain the power to push for higher wages. And even if they don’t, the Fed wants to gradually try to return rates to more normal levels. What it does mean, though, is that there’s no rush to raise rates.
