Context is always a friend.
At a time when central banks globally are under a harsh spotlight for letting inflation hit double digits last year, you would think monetary policymakers would do everything they could to toe the line and limit political scrutiny and the risk of intervention. But central bankers have long shown a tenuous relationship with even basic logic. And so we had Bank of England economist Huw Pill saying the following on a podcast this week: “So somehow in the UK, someone needs to accept that they’re worse off and stop trying to maintain their real spending power by bidding up prices, whether higher wages or passing energy costs on to customers, et cetera.” The outrage machine predictably cranked up to 11, with the vast majority focusing on the sociological implications. How dare he blame inflation on workers seeking to preserve their living standards as household costs soar! My initial reaction was probably along those lines. But upon reviewing the entirety of his comments, turns out that what we have is a perhaps poorly articulated but very standard wage/price spiral argument. Boring and wrong, in my view, but worth understanding as inflation fears continue impacting investor sentiment.
First, a word on how to read—paramount in an age where long-form interviews frequently get boiled down to their most outrageous snippets (which usually involves stringing multiple sentence fragments together into a Frankenstein’s Monster whole), then blasted all over social media. In the vast majority of these cases, the long-form discussion is just fine. The speaker might say something a bit colorful, usually for entertainment purposes, but overall harmless in context. Inevitably, though, the colorful bit gets stripped of that context and presented to others for comment, which are then collated into standard outrage articles.
Often, you can spot this game with some punctuation clues. So it was with Pill’s comments. Most coverage quoted him thusly: “[People] need to accept that they’re worse off …” When you see brackets in a direct quote, it means someone has swapped in a different word. We will do this sometimes in our “Headlines” section, mostly for space-saving purposes or to redact the names of ordinary people profiled in an article we are featuring. But when I see brackets starting a sentence like this, I wonder, is that the actual start of the sentence? What was the original? Is there more that isn’t here? So I tracked down more sources and saw the original quote, and I noticed it (like this sentence) started with “So”—a clue that the statement builds on a prior discussion. Welp, gotta go find that prior discussion! And unsurprisingly, it was a lot more vanilla than the cherry-picked quote.
You can listen to the full podcast yourself, if you like, but CNBC has a pretty good rundown here. Pill was acknowledging that temporary shocks like Russia’s Ukraine invasion’s initial impact on oil price, pandemic-related supply shortages, shipping bottlenecks and more had contributed to inflation. But in attempting to explain how these inflationary forces had worked their way through the economy, he summed it up as a tale of businesses pushing costs on to their customers and those customers trying to offset the pain with higher wages or government subsidies. This is known in economic circles as a wage/price spiral, and if I am interpreting everything correctly, Pill’s stance was that if both sides simply stopped, inflation would ease.
Sooooo … the better question here isn’t who should be upset. It is this: Is he right? If wages keep going up, does that mean inflation is going to stay sky-high, teeing up more interest rate hikes and eventually recession? This very fear dominated headlines throughout the late winter and early spring as economic data kept beating expectations. If businesses and workers agreed to stop, would inflation go back to normal without draconian rate hikes? Is that the simple solution we have all been missing?
Well, no, I doubt it. For one, the entire history of wage and price controls argues against it. Those can artificially restrain increases for a time, but they also destroy the incentives to produce, leading to supply and worker shortages that cause prices and wages to jump once the ceiling is removed. There is a lot of research showing this might actually cause even faster inflation than would otherwise have occurred without intervention. Pill wasn’t arguing for government wage and price controls, but it is hard to imagine a voluntary truce would have a different effect. If companies couldn’t pass on costs, they would go out of business, production would fall even further, and inflation would probably be far worse even without much wage growth. Probably.
Two, this isn’t even a serious real-world discussion in my view, because wages don’t drive prices. Nobel Laureate Milton Friedman showed this in the 1960s. I will spare you the long technical discussion, but he found that while wages do accelerate during inflationary periods, that is because wages follow inflation. They are lagging. We are all living this now, as nominal wage growth trails inflation by a country mile, bringing a fall in inflation-adjusted (aka “real”) pay. If your purchasing power is lower even with your take-home pay going up, then how can you personally be fueling inflation? You are still having to make choices and seek discounts. Depending on what prices do from here and how much your pay grows, it may be a couple years before you regain the buying power you had in, say, 2019. I point this out not to be Debbie Downer, but to show the theory’s illogic.
Now, some good news: Since inflation isn’t a wage/price or cost-push phenomenon, this entire discussion is off target. As Friedman preached, inflation is always and everywhere a monetary phenomenon—too much money chasing too few goods and services. We had this in spades throughout 2020 and even 2021, as central banks massively increased money supply just when lockdowns destroyed productive capacity. COVID disruptions wreaked havoc on the supply of goods, and there was a mountain of new money chasing that limited supply. If this weren’t the case, then businesses wouldn’t have been able to raise prices to compensate for their own higher costs.
But things have shifted. Money supply growth has slowed to a crawl, and in some countries (including the UK) it is falling. Pandemic-related supply disruptions have eased. The egg industry is moving on from last year’s avian flu. Lower fertilizer prices are making it easier for farmers to plant more. Cheaper grain is helping ranchers produce more livestock. So we are slowly entering a world where there are more goods on supermarket shelves and there is less money sloshing around to bid prices higher. That means we should get another monetary phenomenon—disinflation—an adequate amount of money chasing a greater supply of goods and services.
This is a positive from a sociological standpoint, of course. Simply walking into a well-stocked supermarket—one with a good smattering of deals and BOGOs—makes people feel better off. The empty shelves and “limit two per customer” signs of the past three-plus years wreaked havoc on the national psyche. If that era is ending, we are all better off.
It is also good from a market standpoint. As a general rule, bull markets climb a wall of worry, and that climb happens as reality gradually beats low expectations. Continued inflation fears—with the outrage over Pill’s out-of-context comments just one example—are big bricks in that wall. With sentiment still pretty negative and most people ignoring the monetary angle, there is a lot of room for reality to beat expectations and a high likelihood that it does so.
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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.