Home' Trinidad and Tobago Guardian : August 3rd 2014 Contents AUGUST 3 • 2014 www.guardian.co.tt SUNDAY BUSINESS GUARDIAN
FINANCE | SBG19
Inflation may have arrived---the worrisome kind, not
the manufactured kind. Since the Federal Reserve
started "printing money" in 2008, inflation hawks
have warned of runaway price increases that could
overrun the economy. Those have largely been false
alarms; annual inflation during the past six years has
averaged just 1.6 per cent, with a 2.1 per cent rise in prices
during the past 12 months. Many economists have even cau-
tioned that deflation is a bigger risk than inflation.
But new government data provide a genuine reason to worry.
Labour costs rose by 0.7 per cent in the second quarter, the
biggest jump since right before the recession started in 2008.
Economists had been expecting a more modest gain of 0.5
Pay is hardly exploding, but if the value of pay and benefits
continues to grow at a faster pace, it could cause the kind of
inflation that tends to be lasting and trigger the biggest change
in Fed policy since the recession began.
Financial markets tanked following the news of higher labour
costs---with the Dow and S&P 500 both down more than 1.5
per cent---though traders attributed much of the loss to geopo-
litical tensions and other economic indicators that were weaker
than expected. Still, investors have long worried that markets
are too complacent about the risk of inflation and rising interest
rates. That's one reason many investors have been predicting
a 10 per cent or even 20 per cent correction.
The textbooks teach that inflation occurs when too much
money flows through the economy. That's why inflation wor-
rywarts have been miserable for the past six years.
The Fed's controversial "quantitative easing" policy seems
to be a formula for inflation, because the Fed basically creates
money through the purchase of huge amounts of bonds. But
the new money that has flowed to banks has largely remained
on deposit at the Fed, instead of circulating throughout the
In fact, most inflation during this time has come from hikes
in the cost of energy and food, for reasons having nothing to
do with Fed policy.
The inflation equation
What's been missing from the inflation equation is wage
Labour costs are still the biggest contributor to the overall
cost of many goods and services, and they have, not surprisingly,
been stagnant as employers benefit from a large pool of surplus
labor. Average pay has risen by less than 2.0 per cent per year
since 2008, while many companies have been cutting, rather
than expanding, benefits. With pay subdued, Fed policymakers
have reasoned, it's highly unlikely inflation will skyrocket and
they've been right.
If the latest pay gains stick, however, companies will try to
pass on their own higher costs to consumers in the form of
higher prices. That's the kind of inflation the Fed worries
Modest inflation---say, between 2.0 per cent and 3.0 per
cent---wouldn't necessarily be a bad thing, especially if pay
gains for workers exceeded price increases. That's how people
get ahead. But the arrival of legitimate inflation could also
force the Fed to rein in its super-easy monetary policy sooner
than expected, which could rattle financial markets and under-
mine a growing sense of optimism about the economy.
The Fed is already close to winding down its quantitative
easing program, with the final bond purchases likely to come
in October. The Fed has telegraphed that move, and the markets
have adjusted. The wild card now is the timing of the Fed's
first interest-rate hike, which many investors expect sometime
in the middle of 2015.
The Fed's short-term rates have been close to 0 since 2008,
which has only been possible because inflation has been so
low. Since raising rates is the traditional way to head off
inflation, the Fed could move sooner than markets anticipate,
if it feels the risk of inflation is intensifying.
Job growth has been strengthening, with the unemployment
rate dropping from 6.7 per cent to 6.1 per cent so far this year.
So it makes sense that wages would rise as labour-market
slack tightens. "If the unemployment rate keeps declining,
compensation pressures simply have to increase," writes econ-
omist Joel Naroff. "Most members of the Fed appear to believe
it will be a lot later and not very rapidly, but I am not that
The recent selloff in stocks and bonds---along with rising
rates on Treasuries---represents the standard reaction when
investors feel inflation might become a problem or the Fed
might tighten. It's also possible the recent compensation spike
was an anomaly, with labor costs set to settle back into a
Inflation has certainly pulled a disappearing act before.
Inflation looks real this time
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