Since the worst of the financial crisis has passed, those watching the markets and the economy have been waiting for one thing:
And at least one economist thinks inflation might already be here.
So far, of course, there’s been no inflation to be found anywhere. “Core” inflation — which excludes the more volatile cost of food and gas — has been running at around 1.7% or so over the last couple years, below the Federal Reserve’s 2% target.
But looking at consumer prices isn’t enough. What really needs to be in place for prices to take off are wages, which have also been more or less flat compared to consumer prices over the last several years.
Recent data, however, suggest that this paradigm has shifted, and Deutsche Bank economist Torsten Sløk argued on Tuesday that the moment at which wages — and as a result inflation — begin to really take off has already passed us by.
In an email on Tuesday, Sløk asked, “What if we are all wrong?”
“The market believes inflation will not be a problem and the Fed believes inflation will not be a problem,” Sløk wrote. “But the risks are in my view rising that we are underestimating the amount of inflation in the pipeline. Why? Because the economy is moving closer and closer to full capacity and once we hit full capacity inflation takes off. We are already seeing this in wages.”
What Sløk is talking about when he describes an economy as “full capacity” is an economy in which each job and production increase that the current business cycle is going to create without stoking an increase in wages and consumer prices has already been created.
Over the last year we’ve seen about 3 million jobs created while the unemployment rate has marched down to 5.5%. And in the last month, a number of measures have indicated that wages are finally starting to take off.
Additionally, the number of job openings exceeded the number of jobs filled last month and the average number of days to fill a job has risen to 26 days, more than the 23 days it took to fill a job in 2006. Both of these stats indicate a labour market that has begun to really “tighten,” or see the balance of power shift from employers to employees.
On Wednesday, we’ll get the latest monetary policy decision from the Federal Reserve. We’ll also see the Fed’s latest economic projections, which include its outlook for GDP, inflation, and the unemployment rate.
Right now, the Fed sees the economy hitting NAIRU, or the non-accelerating inflation rate of unemployment, at 5.1%. This means that until the unemployment rate hits 5.1%, there will be no inflation — in prices or wages — in the economy.
But in Sløk’s eyes, we may have already passed this moment.
“In my view we have already hit the NAIRU sometime in 2014 and that is why wages are moving straight up,” Sløk argues. “Or put differently: Why did the Employment Cost Index begin to trend higher a year ago? Because the labour market reached full capacity and as a result prices started going up.”
Sløk takes this even further, writing, “
The risks are rising that we are all wrong with our benign inflation outlook and that higher labour costs will begin to spill over to services inflation in the economy, with the same hockey stick pattern we are seeing in the ECI.“
For Sløk this is the money chart: the employment cost index.
Unlike average hourly earnings, the employment cost index captures things like employee benefits in addition to wages and salaries, which gives, in Sløk’s view, a more complete picture of what it really costs to employ people.
In March, this measure rose 2.6%, which for Sløk is a harbinger of things to come.
In his email, Sløk outlines that we ought to recall that NAIRU, or this idea of a labour market at “full capacity,” is not one we some come and go in a clean process. Once wages and inflation start to take off, these things are here to stay.
The question, of course, is whether what we’ve seen in wage growth is a head-fake or the future of the economy.
The answer means everything for the Fed, which will likely raise rates sooner and faster than the market expects if we’re really taking off, or will decline to act quickly if recent data doesn’t hold up under further scrutiny.
And while Sløk’s specific view that the economy is exactly where the Fed wants it to raise interest rates is a minority one, his framework for thinking about inflation is worth considering. Inflation is the kind of thing you don’t know until you see, and so it is at least worth asking if that moment for the US economy has come and gone.