Perhaps the key question regarding the higher level of inflation in the United States is whether it is likely to be transitory, and therefore to fade on its own, or whether it is likely to increase. be permanent unless aggressive policy action is taken – such as further interest rate increases by the Federal Reserve.
The case that current inflation is likely to go away on its own often argues that inflation was caused by a confluence of events that are unlikely to last: people spending money in some limited sectors of the economy when pandemic restrictions shut down other parts of the economy, the resulting supply chain misfires in part, and soaring energy prices. The hope or expectation is that as these factors fade, so will inflation.
The argument that inflation is likely to be permanent is linked to the “great quitting” in US labor markets. Companies are trying to hire. Vacancy rates are very high. The upshot is that upward pressures on wages are likely to keep inflation high unless or until the Fed triggers additional interest rate increases that are likely to to cause a recession within a year or two. Let’s review some of the evidence on job vacancies and inflation, then address the obvious concerns of “blaming” higher wages for causing inflation.
To start, here’s the basic numerical count of vacancies since 2000. Note that the number was growing even before the pandemic recession in 2020. Indeed, if you squint really hard, you can imagine a more or less straight line from from pre-pandemic vacancy trends to vacancy numbers that aren’t too far off from current levels.
But from an inflation perspective, what really matters are job vacancies relative to the number of unemployed. Worries about wage inflation arise when there are a lot of vacancies and a relatively small number of unemployed people seek those jobs. Here is the unemployment/vacancy ratio of the Job Vacancies and Labor Turnover Survey (JOLTS) by the US Bureau of Labor Statistics. Again, note that this ratio was already trending down before the pandemic. Also note that when this ratio falls below 1, the number of unemployed is lower than the number of vacancies.
The “Beveridge curve” is another way to look at this data. This curve represents the unemployment rate on the horizontal axis and the job creation rate on the vertical axis. The usual pattern here is a generally downward relationship, which intuitively makes sense: that is, periods of high unemployment also tend to be periods with lower job opening rates. Indeed, you can see in the lower set of colored lines, all blended together, that the economy of the first decade of the 2000s was essentially moving back and forth along a Beveridge curve.
But then the Beveridge curve shifts upwards during the period from July 2009 to February 2020: that is, for a given level of unemployment rate, the job vacancy rate was higher than ‘previously. And since the pandemic, the Beveridge curve has climbed even higher to the black line: again, for a given level of unemployment rate, the job vacancy rate is higher than before. In other words, employers are looking to fill more jobs now than they were before when unemployment rates were about as low.
In short, no matter how you look at it, vacancies are very high right now. I don’t think this phenomenon is well understood yet. But workers are quitting their jobs at high rates, often to take another favorite job, and the employment-to-population ratio of American adults has yet to return to pre-pandemic levels.
These vacancy patterns set the stage for the research paper in Laurence Ball, Daniel Leigh and Prachi Mishra, “Understanding US Inflation During the COVID Era”, just published as part of the Brookings Papers on Economic Activity (Fall 2022, text as well as video of the presentations and comments available). The research document is full of models and calculations, and will not be particularly accessible to the uninitiated. But the basic idea is simple.
The authors examine the recent rise in inflation. They find that when looking at the overall inflation rate, changes are indeed often due to factors such as supply chain issues, spikes in energy prices, and more. But if you just focus on “core” inflation, disregarding the change in food and energy prices, they find that the relationship between job vacancies and the unemployment rate is the main driver. In other words, yes, some of the inflation over the past two years is temporary, but not all of it. Further, they find that breaking the back of that underlying core inflation will likely require further interest rate hikes from the Fed and higher unemployment – which seems to me to be the type of downturn multidimensional economic product and labor markets that is called a “recession.”
A common response to discussions of how higher wages can drive up inflation is to accuse the storyteller of simply opposing higher wages. This response has a nice “gotcha” vivacity to it. One can easily imagine a group of sympathetic listeners vigorously nodding their heads and shouting “you tell them” and “preach it” and so on. But in an analytical sense, the answer is confused. Over time, the only way to have higher and sustainable wages is to build them on the basis of higher and sustainable labor productivity. Perhaps the workplace-related innovations triggered by the pandemic experience will lead to increased productivity, but at least so far that’s not showing up in the data. Otherwise, higher wages can trigger what used to be called the wage-price spiral: that is, higher wages drive up prices and higher price levels drive higher salaries. The appropriate social goal is to have higher wages who also have greater purchasing powernot higher wages that perpetually pursue higher price levels.
Ball, Leigh and Mishra’s article is of course only a set of estimates, although they come from a group of reputable economists and have been published in a top publication. But they are not the only ones to suggest that the pattern of very high job vacancies given the level of unemployment could be the key factor driving up underlying inflation.