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Outside the Box: America’s hidden hedge against inflation

When the Biden recovery began in earnest earlier this year, the good news was greeted almost immediately by fears of inflation. If the delta variant more recently muted those concerns, strong jobs numbers and anticipated labor shortages are likely to rekindle the same worry.

To weigh the concern properly, we first need to reckon with the quiet but profound way traditional indicators distort our count of underemployed and undercompensated workers. A deeper statistical dive reveals that employers who pay a living wage are at no real risk of exhausting the U.S. supply of labor. As a result, the specter of widespread wage inflation is much more far-fetched than commonly understood. 

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Those who pay close attention to employment measures are likely aware that headline unemployment statistics calculated by the U.S. government fail to account for the millions of working-age adults who give up the search for work altogether.

Supply outstrips demand

But our broader perceptions are bedeviled by an even bigger problem. Workers who are earning a poverty wage of less than $20,000 a year or who are getting by with a part-time gig are counted by the Bureau of Labor Statistics as among the “employed.” If you count them more appropriately among the unemployed, one thing becomes abundantly clear: Domestic labor supply far outstrips demand.

The statistics are breathtaking. In August, the headline rate of unemployment, reported by the BLS, was 5.2%. But the true rate of unemployment was actually 22.8%. This was calculated by the Ludwig Institute for Shared Economic Prosperity using the BLS’s underlying data but counting as unemployed those left out of the headline statistic. (And this does not count those so discouraged that they have given up the search for work.).

In other words, closer to a quarter of America’s working-age population is either earning a poverty wage or subsisting on the money they earn from part-time gigs (or both). 

This distinction has significant macroeconomic implications.

Theory of inflation

Prevailing economic theory holds that if unemployment falls below a certain level, employers will feel compelled to raise wages. To cover augmented labor costs, businesses will then have to raise prices for goods and services. Price hikes will then put additional pressure on employers to raise wages again. And if left unabated, so the theory goes, that cycle risks spinning out of control, much as it did during the period of “stagflation” that defined 1970s. That phenomenon was driven by oil-price shocks that may not be so analogous to the current one, but which remains the inflation hawks’ bloody shirt. 

Today, fear of another inflationary episode is driving a small coterie of hawks to take pre-emptive action. Once an inflationary cycle begins, they worry things will quickly spin out of control. So they want the Congress to pare back new federal investments and for the Federal Reserve to raise interest rates sooner rather than later. Better, from the hawks’ point of view, to take Washington’s foot off the gas to nip the specter of inflation in the bud. 

But their logic ignores more recent, and more relevant, history.

In 2015, several years into the Obama administration’s recovery, the traditional unemployment figure fell to 5.0%. Then, as now, the mere hint of wage-driven inflation sparked a hawkish outcry. Fearing that a tighter labor market might spur a new inflationary cycle, and despite the fact that wages never rose in any substantial way, the Federal Reserve decided to raise interest rates for the first time since the financial collapse. 

Because the global and domestic economies softened soon thereafter—growth largely flattened in 2016—the question of why wages never rose floated into the ether. But now, LISEP’s figures provide a clear rationale: While the traditional figure reported in November 2015 suggested unemployment had fallen dangerously low—though, of note, considerably higher than January 2020, when President Donald Trump was crowing about a solid economy—LISEP’s measure suggests that unemployment actually stood at 27.3%.

Invisible labor supply

In other words, it remained easy for employers to hire from this enormous supply of purportedly “employed” workers, a group that essentially acts as a hidden hedge against inflation. And the same thing is true now.

To be sure, it’s not my contention that the underlying macroeconomic theory is wrong. I accept that if true unemployment figures fell below a certain figure, the labor shortage might spark a new round of real wage inflation. But we’re nowhere near that point.

As long as millions of “employed” Americans are desperately seeking more or better work, policy makers should be very wary of calls to raise interest rates or pare back federal spending in service of combating rising prices and wages. Until workers see the benefits of a truly tight labor market, we ought not try to rein in economic growth.

Eugene Ludwig, a former U.S. comptroller of the currency, is chair of the Ludwig Institute for Shared Economic Prosperity.

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