Labor costs 'all about inflation expectations,' economist says

University of Chicago Economist Tomas J. Philipson joins Yahoo Finance Live to discuss how inflation continues to affect labor costs.

Video transcript

ADAM SHAPIRO: Tomas J. Philipson is a University of Chicago economist. It's good to have you here. And one of the things we saw in the recent data is that employers are spending, what, 4% more on wages than last year. Now that sounds like a good thing for most people, but help us understand what does that mean going forward. Will we continue at this-- they call it wage inflation, I guess, pace. And what happens to investments and consumers if that's the case?

TOMAS J. PHILIPSON: Yeah, I think the main issue in the labor markets obviously in 2021 has been that the main competitors for many small businesses in terms of getting labor has been their government really in some sense by paying people to not work. So the $300 or $600 we saw in 2021 correspond to $7 or $15 per hour increase in the minimum wage or on the wage they already had. So that presumably had businesses compete up their way just to compete with that offer from the government. And that's kind of what we're seeing the hangover right now.

Going forward, I think, you know, this is all about inflation expectations, I think, because there's a lot of cost of living adjustments in these wages going on. Both the unions, even though unions are a small share of the labor force, are now demanding-- they're foreseeing these price increases on demanding wage hikes in response to those. And that obviously will then translate into higher prices that gets pushed on from the manufacturers. So I think the inflationary spiral that economists are worried about is really at the heart of what's going on now with the wage increases.

EMILY MCCORMICK: Tomas, considering this inflationary backdrop and the tight labor market that we're currently in, economists at Bank of America and JP Morgan both today increased their forecast on the path forward for interest rate hikes out of the Fed. Now B of A now sees seven quarter point rate hikes this year, and JP Morgan is looking for five. How likely are these aggressive predictions going to be what ultimately comes out from the Fed?

TOMAS J. PHILIPSON: Yeah, I mean, I think most economists were surprised how mild the Fed came out with, you know, 3/4 or 75 basis points in increases in 2022 projected. On the other hand, we haven't had a Fed with a $9 trillion balance sheet, which is 40% of GDP.

So there's a lot of offloading there that could potentially help as well. I think that reflect, I think, that most people fear that with these new inflation numbers coming out today and also the last few months, that there needs to be something more aggressive done. And historically, right, rate hikes have been in the 2% or 3% to fight inflation. And we don't see the Fed taking that stand yet, at least.

ADAM SHAPIRO: If you were a voting member of the FOMC, what would you advise in the meeting? Would you-- I mean, we saw the big banks saying expect even more rate increases than had been projected. But you've just alluded to the other tools they can use to ramp things up.

TOMAS J. PHILIPSON: Yeah, so there's two tools, right? They can sell off their balance sheet, and they can raise the rates. And I think I'm not alone in that a lot of economists fear that what they're proposing is not aggressive enough or not hawkish enough. So basically, I think many people would like a more aggressive stance to their path going forward.

EMILY MCCORMICK: In terms of the inflation data and really the broader economic data that we've been getting recently, in addition to the PCE data out this morning, we also got the Consumer Sentiment Index out from the University of Michigan that fell to the lowest since 2011 for the final January reading. And even if we look back to fourth quarter GDP that we got earlier this week, the details showed that most of that increase had come from private inventory builds, more so than personal consumption. I'm wondering, what is the state of the consumer right now? And is there a risk for a major slowdown in spending and consumption?

TOMAS J. PHILIPSON: Yeah, I think they're very scared. This is a policy induced inflation that we're seeing, right? We have a triple threat to price increases. One is, it's the first recession we've had, the pandemic, where we had disposable income going up through government transfers. Usually, it goes down in a recession-- always, actually.

And then we had supply restrictions by the new administration mainly on energy, which obviously goes into a lot of prices, but also in other sectors as well. Both of those forced prices up. In addition, you have a very accommodating Fed with the money supplies really going way up, which is an inflationary pressure. The other two are more like relative price increases in those sectors.

But I think people are scared because, you know, especially on fixed income, this is a major threat to them, and they're getting worried. And it also counteracts a lot of what the administration is trying to do. So for example, the administration has said that they lowered child poverty in half, and that's not true at all in real terms.

And it's actually not true in the data because the child tax credit that they basically extended amounted to about a 7% increase in nominal income for those households on average, which was eaten up completely by inflation then in that neighborhood. So I think it's both the government policies they're trying to institute and the people faced with those policies are getting a little bit worried.