Inflation is the cause, not the result, of ‘overheating’ labor market, study finds

CNN
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In 2022, when the job market was so hot that Beyoncé even released a song about it, Americans were changing jobs in large numbers, increasing their wages.

The Great Resignation was in full swing.

This has fueled fears of a “wage-price spiral” – in which wages and prices perpetually rise and feed off each other.

But what appeared to be a sharply rising labor market was actually a symptom – not the cause – of the recent surge in inflation, according to a new study exploring the consequences of an unexpected rise in labor market prices .

Maybe it wasn’t even a hot job market: Rising prices ate into people’s wages, forcing some workers to make drastic and costly decisions to change jobs, according to the new working paper titled “A Theory of How Workers Keep Up.” Inflation.” This led to a rise in job vacancies, while layoffs and the overall unemployment rate remained historically low, giving the appearance of a tight labor market.

“There are periods when shocks to labor demand put upward pressure on real wages, which then feeds through to producer prices,” said co-author Erik Hurst, an economist and professor at the Booth School of the University of Chicago. Business. “In periods when demand for labor is increasing, you will see other signs of a hot labor market, such as rising real wages; you will see employment increase; you will see the job search rate of the unemployed increase.

“None of these things happened during this period,” he added.

Additionally, real wages (which take into account the impact of inflation) are about 4.4% lower than expected, based on pre-pandemic trends, he said.

Additionally, data from the Bureau of Labor Statistics showed that year-over-year real average hourly wage growth has fallen for 25 consecutive months. The average hourly wage has exceeded inflation since May 2023, but has still not returned to its level before the inflation peak.

In early 2021, when workers were rapidly losing money, they likely took steps to prevent that from happening, according to the paper co-authored by Hurst with economists at Columbia University, Federal Reserve Bank of Atlanta and the University of Texas at Austin.

These potential responses included renegotiating wages at their existing company, exploring the labor market to move to another company, or “simply unemployment if they find their eroded wages too low,” the economists write.

Each of these actions carries additional costs, they noted.

Ultimately, renegotiations can make future salary changes rarer and signal a lack of commitment. Job searching has been shown to have direct monetary costs as well as indirect costs (stress, health, productivity), and unemployment can carry serious risks, including loss of wages and the ripple effects that come with it. result, as well as an erosion of skills, according to research.

“Part of the ‘Great Shuffle’ could have been due to inflation,” Hurst said.

Yet as this activity occurred and the rate of job vacancies relative to unemployment reached historically high levels, it sowed uncertainty among academics, economists and key policymakers, the paper said.

Notably, in November 2022 (six months after the start of the Federal Reserve’s monetary policy) to raise interest rates) Fed Chairman Jerome Powell said that “the broader picture is one of an overheated labor market where demand outstrips supply.”

It wasn’t until two years later, when the job market seemed to be rapidly weakening, that the Fed finally began lowering interest rates via a giant half-point cut.

“We know that policymakers were reluctant to act too soon, because they were concerned about potential inflationary pressures from the ‘hot’ labor market,” Hurst said. “A better understanding of what is happening in the labor market will therefore be a useful input to potential policy decisions.”

This could include a closer look at how wages are changing, who is quitting, who is being hired and whether there are any distinct changes in how job seekers are finding work. All of this could help play a key role in assessing whether the labor market is causing inflation – or whether it’s the other way around.