In Fisher Investments UK’s experience, hot inflation (broadly rising prices across the economy) often spurs wage-price spiral claims amongst financial publications we follow. Based on our research, the wage-price spiral theory posits inflation leads to higher wages, which companies must then offset by raising prices. That, in turn, allegedly leads to even hotter inflation, more wage hikes, hotter inflation still, and so forth. Commentators we follow dub it a vicious cycle – pointing to higher wages amidst 2022 and 2023’s fast global inflation as warnings more hot price gains were ahead. Yet we think the wage-price spiral theory is fundamentally misperceived. In Fisher Investments UK’s review, understanding this theory’s shortcomings can help investors see past claims rising inflation and wages threaten equities.
The wage-price spiral has its roots in the Phillips Curve – an economic model that purports unemployment and inflation’s inverse relationship (i.e., lower unemployment is associated with faster inflation and higher unemployment is associated with slower inflation). That some developed-nation monetary policymakers publicly cite the theory seems to add to its credibility amongst commentators we follow. We think there is some truth to the thinking rising inflation leads to higher wages: based on Fisher Investments UK’s research, fast inflation historically has meant workers demand higher pay to offset inflation-driven expenses. Meanwhile, we have found employers may choose to hike wages to compete for labour in a low-unemployment environment.
However, we think the wage-price spiral theory takes this thinking too far. As American economist and Nobel laureate Milton Friedman taught in the late 1960s, firms compete for labour using real (inflation-adjusted) wages. i That implies wages follow inflation, not the reverse. Said another way, Fisher Investments UK thinks the wage-price spiral theory essentially argues inflation causes inflation, a logical fallacy.
In our view, supply and demand dynamics reveal why wage-price spiral thinking is flawed. For one, we have found higher wages draw in more workers – adding to supply, which allows wage growth to slow. Meanwhile, firms can find alternative ways to meet their production needs other than adding to headcount (e.g., technological advances to maintain or improve productivity with fewer employees). That can also cause costs to stabilise – prices and wages needn’t spiral upward together.
Fisher Investments UK’s reviews of recent real-world examples help counter wage-price spiral claims. Consider Japan in early 2023: in March, wage negotiations between unions and employers led to wage hikes averaging 5.28%.ii These hikes followed an uptick in Japanese headline inflation – which rose from 0.5% y/y in January 2022 to a 4.4% peak in January 2023 – and stood at 3.3% at the time of the negotiations.iii Six months after negotiations wrapped? Inflation was slower – September’s rate was 3.0% y/y.iv Negotiations and wage hikes didn’t drive inflation higher, as wage-price spiral theorising would predict.
Fisher Investments UK’s research reveals that UK and American data reveal similar realities. In Britain, the Bank of England (BoE) issued wage-price spiral warnings throughout 2023, amidst monthly wage growth averaging 7.5% y/y (2023 data through August).v Yet as wages rose, UK inflation slowed – from its 11.1% y/y peak in October 2022 to 6.7% in September 2023.vi In America, wage growth accelerated from 3.0% y/y in May 2021 to 6.7% in June 2022.vii After remaining unchanged for two months, wage growth eventually slowed in September 2022.viii US inflation? Its slowdown came fully two months earlier, in July 2022.ix Moreover, US wage growth has outpaced inflation from February 2023 through October 2023 (the latest data available).x
In Fisher Investments UK’s review, understanding the misperceptions surrounding the wage-price spiral can benefit investors’ portfolio decision making – by helping see inflation-driven wage growth won’t hurt equities, as many commentators we follow argue. For example, in high and rising inflation environments, some might claim wages must rise – hence, crushing firms’ margins and wrecking equities. But understanding rising wages follow, rather than lead, prices can help you filter out these warnings and focus your attention elsewhere (e.g., on economic and political drivers that we think equities care more about). Likewise, in our view, if you see strong employment, there isn’t reason to automatically assume overall prices will soon rise higher and faster.
What about the 1970s’ global inflation and economic malaise – which some commentators we follow claim was wage-price spiral-driven?xi In Fisher Investments UK’s review, the 1970s oil shock, excess money supply (the amount of money circulating) growth and price controls underpinned hot inflation then – not a wage-price spiral.xii We think recent history supports this view: the UK and parts of Europe applied limited price controls on industries like energy in 2022 and 2023 – which, in our opinion, kept inflation elevated for longer by impeding price signals and slowing utilities’ passing lower input costs to consumers.xiii Moreover, the US didn’t implement price controls – and its inflation began cooling earlier.xiv Wage-price spirals don’t explain inflated prices – historic or recent – in Fisher Investments UK’s review.
Disclaimer
This document constitutes the general views of Fisher Investments UK and should not be regarded as personalised investment or tax advice or a reflection of client performance. No assurances are made that Fisher Investments UK will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. Nothing herein is intended to be a recommendation or forecast of market conditions. Rather, it is intended to illustrate a point. Current and future markets may differ significantly from those illustrated here. In addition, no assurances are made regarding the accuracy of any assumptions made in any illustrations herein. Fisher Investments Europe Limited, trading as Fisher Investments UK, is authorised and regulated by the UK Financial Conduct Authority (FCA Number 191609) and is registered in England (Company Number 3850593). Fisher Investments Europe Limited has its registered office at: Level 18, One Canada Square (NYSE:SQ), Canary Wharf, London, E14 5AX, United Kingdom. Investment management services are provided by Fisher Investments UK’s parent company, Fisher Asset Management, LLC, trading as Fisher Investments, which is established in the US and regulated by the US Securities and Exchange Commission.
Investment management services are provided by Fisher Investments UK’s parent company, Fisher Asset Management, LLC, trading as Fisher Investments, which is established in the US and regulated by the US Securities and Exchange Commission. Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates.
i “The Role of Monetary Policy,” Milton Friedman, The American Economic Review, Vol. LVIII, March 1968.
ii “Japan’s Largest Union Reaches Early Deal For Higher Pay,” Staff, Reuters, 9/3/2023. Accessed via the Internet Archive.
iii Source: FactSet, as of 14/11/2023. Japanese consumer price index (CPI), January 2022 – September 2023. CPI is a government-produced index tracking prices of commonly consumed goods and services.
iv Ibid.
v “BOE Official Suggests UK Unemployment May Need To Reach 6%,” Tom Rees, Philip Aldrick, Bloomberg, 3/11/2023. Accessed via Yahoo! Finance. Office for National Statistics, as of 10/11/2023. Average weekly earnings annual growth rates in Great Britain, seasonally adjusted, January 2023 – August 2023.
vi Source: FactSet, as of 10/11/2023. UK consumer price index (CPI), October 2022 – September 2023.
vii Source: Federal Reserve Bank of Atlanta, as of 10/11/2023. Three-month moving average of median wage growth, hourly data.
viii Ibid.
ix Source: FactSet, as of 10/11/2023. US consumer price index (CPI), July 2022 – October 2023.
x Ibid and Federal Reserve Bank of Atlanta, as of 10/11/2023. Three-month moving average of median wage growth, hourly data.
xi “Why It’s Not Quite Back To The 70s With Talk Of Food Price Controls,” Larry Elliott, The Guardian, 30/5/2023.
xii Source: FactSet, as of 15/11/2023. Statement based on US M2 year-over-year growth, 1969 – 1979 (M2 accounts for mostly notes, coins, bank reserves, checking accounts, savings deposits, money market funds and small time deposits).
xiii See note xi.
xiv Source: FactSet, as of 14/11/2023. Statement based on US, UK and eurozone consumer price indexes, 31/12/2021 – 14/11/2023.
