Inflation Is Set to Fall. The Fed Should Back Off.
Wage growth has been experiencing a historic slowdown and inflation is sure to follow. Will inflation hawks be willing to take yes for an answer?
A little over a week ago, I tried to make the case for a more relaxed view of the current inflation situation than might be gleaned from the alarmist analyses emanating from top Fed officials and some prominent commentators — not least Jason Furman, former chief economist in the Obama administration and a notable voice of inflation hawkery. Responding to new data released late last month showing a sizable jump in the core inflation rate in January, Furman published an op-ed in the Wall Street Journal headlined “To Fight Inflation, Fed Tightening Should Go Faster and Further.”
My basic argument, as Eric Levitz of New York Magazine efficiently summed it up in a tweet, was that, “looking beyond a month-to-month time horizon, wage growth more or less determines price growth [and] wage growth is rapidly decelerating.”
I showed, first, that the correlation between wage growth and inflation, though not very impressive within a one-month or three-month timespan, becomes extremely strong at longer time horizons: the R-squared (i.e. the strength of the correlation) rises to 0.63 at a one-year horizon and 0.78 by four years.
Second, I showed that wages have indeed been rapidly decelerating — so rapidly, in fact, that in the forty-odd years since the massive disinflation engineered by former Fed chairman Paul Volcker in the early 1980s, only four months have seen faster wage deceleration (measured by the twelve-month change in the twelve-month growth rate) than what we experienced in January of this year. (And in three of those four other months, the data were clearly distorted by the pandemic shutdowns of spring 2020.)
Essentially, I’m saying that wages are a kind of “super-core” inflation index. Economists and policy makers pay close attention to measures of “core” inflation, which, in different ways, strip out the more volatile or transitory components of the product basket. There are core indexes that exclude just food and energy prices; others that try to more systematically identify and exclude the most volatile product categories; and still others that exclude the outliers (i.e. the products with the highest and lowest inflation rates each month, rather than those with the most volatile rates).
But in all cases, the idea is that by abstracting from the random noise and fleeting shocks that cause “headline” inflation to fluctuate so much, these indexes can give a better gauge of the underlying inflationary forces at work — and therefore a better clue to what inflation might do in the near future. In practice, what I’m arguing is that the rate of wage growth is the “most core” price index, as Elon Musk might put it.