eco TV Week

Wage-price loop: low risk but one to watch

5/13/2022

One of the economics themes currently being debated, the possible start of a wage-price loop is a cause for concern. However, at first and under normal conditions (which, it is true, is not the case right now), a wage-price loop is not a problem in itself.

Hélène BAUDCHON

TRANSCRIPT // Wage-price loop: low risk but one to watch : May 2022

One of the economics themes currently being debated, the possible start of a wage-price loop is a cause for concern. However, at first and under normal conditions (which, it is true, is not the case right now), a wage-price loop is not a problem in itself. It is initially the sign of an economy that is working normally, as expected, as more growth and less unemployment drive prices and wages upwards in a self-sustained loop. Today, however, the situation is complicated by the fact that inflation is driven not only by strong demand but also by negative supply shocks.

The fear, particularly for central banks, is that the machine could spin out of control if wage demands – to make up for the loss of purchasing power due to inflation – and companies’ price rises – to make up for higher wage costs (and input prices) – mutually fuel and reinforce each other. The wage-price loop then becomes a problematic spiral. To avoid this, well anchored inflation expectations play a decisive role because it is a balancing force that helps to contain the wage-price loop.

Where do we stand today? The conditions are in place for more significant wage increases: low unemployment rates, hiring difficulties, surging inflation, companies’ margins at a more comfortable level. This acceleration in wages can be seen in the United States and in the United Kingdom. It is still to come in the Eurozone but it could start to materialise in the second half of this year. Does this mean that a wage-price loop is already in play or about to begin? It’s hard to say.

Indeed, acceleration in wages is a first step: signs of a feedback on inflation, and on wages once again and so on, are still uncertain. Admittedly, companies seem to have greater pricing power. Higher inflation expectations also seem to be emerging and need to be watched. Increases in minimum wages in various parts of the eurozone could also give the feeling that a wage-price loop is beginning. But if this is the case, it is still prudent for now.

According to an ECB experimental forward looking wages tracker, the increases set out in recent wage settlements stood at 3% in 2022 and 2.5% in 2023. This is significantly higher than over the last 10 years but this is not an excessive pace either and there are no signs of it spiralling. And even if the risk of such a spiralling is low, it is closely monitored by the ECB. To keep expectations well anchored and to ensure its credibility, the ECB is getting ready to embark on hiking the deposit rate, with a first move in July. How quickly and how far? We’ll have the opportunity to discuss this again in future episodes of EcoTV week. Thank you for watching and join us again next week for a new issue.

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