Believing Their Own Spin: How the Fed’s Wage-Price Myth Will Tank the US Economy

Just yesterday Federal Reserve Chairman Jerome Powell sealed the deal on a 50-basis point rate hike at the committee’s May meeting. His comments sent stocks on a 45-degree slide lower for the rest of the day but did little real damage to the markets.

They’ve been soft-peddling this rate hike (and the ones that are coming) for weeks. 

In fact, if they soft-peddled it any more softly, the market might have gone comatose. 

The Fed’s main argument for the higher prices we’re seeing today stems from the current tight labor market. According to the Wall Street Journal:

Mr. Powell warned of growing supply-and-demand imbalances in the U.S. labor market that some economists worry could fuel a wage-price spiral that drives inflation higher as workers bid up wages.

It’s called a wage-price inflation spiral. Higher wages mean more disposable income which leads to greater demand for goods which leads to higher prices which, in turn, leads to demand for higher wages.

But is this really the case?

And if it’s not, what will the likely outcome of their efforts be?

Let’s take a look at some numbers…

A Brief Economic Breakdown

Let’s start with what we all know… Inflation is ridiculous.

As reported by the BLS, CPI was up 8.5% year over year in March.

US Inflation


Of course not all inflation hit consumers the same way. Let’s take a look at some of the component categories that went into this number starting with food…

“Food at home” (in other words, your grocery bill) was up 10%.  Within that category your proteins (meat, poultry, fish and eggs) rallied 13.7%, dairy was up 7% and cereals and baked goods bumped 9.4%.

Dining out at a nice restaurant cost 8% more as well.

On the energy side, not surprisingly, commodities like fuel oil were up 70.1% and gas 48% putting a big kick into the overall number. By comparison, energy services saw more “modest” increases: electricity was up 11.1% and piped gas rose 21.6%.

But food and energy are always the bad guys. How’d everything else do?

Adding to your wardrobe cost more with clothing up 6.8%. It cost you 23.6% more to fly anywhere. Getting around by car was no better: new car prices were up 12.5% while used car prices soared 35.3%!  And it cost you 4.9% more to maintain your vehicles — new or used.

In the face of all this, thankfully, alcohol prices were up only 3.7%!

But There Has Apparently Been Good News Too… 

Despite these rising prices, retail sales numbers appear to show continued healthy growth in the economy…

Source: US Census Bureau

If we break these down by type of business, spending on groceries increased 8.4%, gas station spending rose 37%, spending on clothing was up 7.3%, spending on dining out rose 19.4%. 

One of the only businesses that saw a decline in sales was the auto industry with sales dropping 1.2%. (Other industry sales that were down included electronics and appliance stores along with sporting good / hobby / musical instrument / book stores.)

Now ordinarily an increase in retail spending is considered a positive for the economy — it shows consumers have a high level of confidence and are willing to part with their disposable income. So this spike in retail sales would appear to suggest that the Fed’s wage-price theory may be the case. 

But let’s not pop the champagne just yet. 

In the chart above from the Census Bureau, retail sales are measured in dollars spent, not necessarily things bought. So when you consider the fact that spending on clothing increased over 7%, remember that the price of clothing had jumped by almost as much. More dollars are changing hands, but consumers are not necessarily buying more things

That does not fuel a growing economy — or drive prices higher.

A Look At The Wage Side Of The Equation

So how much more are workers making these days? 

Hourly earnings recently saw a boost of 0.4% month over month. 

Hourly Earnings MoM


Unfortunately the accompanying report from the Bureau of Labor Statistics put that increase in perspective…

If you compare apples to apples, the trend has been pretty obvious…

Inflation YoY


Hourly Earnings YoY


Real wages are actually falling thanks to inflation. Which means consumers are spending more to buy the same things they’ve bought in the past.

But even in nominal terms, have higher wages been a driving factor behind rising prices? If higher wages mean more disposable income which lights the inflationary fire, there should be a correlation between the two.

Here’s a snapshot of inflation on top of personal disposable income:



Disposable Income


You can see the spikes in disposable income in March 2020, January 2021 and March 2021 and on the heels of the last one, inflation started to move higher in earnest. So again, is the Fed right? Are we witnessing the beginning of a wage-price spiral? Well they would be if those spikes were caused by soaring wages.

But they weren’t.

Those three monthly spikes were the dates when the government started spreading around some $5.1 trillion in stimulus payments. Free money. Not wages. And you can see that inflation continued to scream higher even after that additional disposable income was spent.

Consumers (and the Economy) Aren’t in Great Shape

A few more charts to drive the point home.

Personal consumption expenditures are down…


Which is reflected in retail sales (when viewed as percentage increases/decreases year over year rather than simply dollars spent)…


Personal savings are in the tank…


All while employment has almost reached pre-pandemic levels…


You can draw your own conclusions, but from where I stand, a tight labor market and “soaring wages” really aren’t the culprits.

Like I’ve said repeatedly, this is the first time in decades that the Fed is stepping into the ring to do battle with actual secular inflation caused by massive supply shocks around the world — not simply an overheated economy resulting from too much easy money.

The Fed’s hope is that they can engineer a “soft landing” — slow growth enough to cool prices without pushing the economy into a recession. But given that the economy isn’t looking particularly strong, that won’t take much of a push.

And in light of that, there was one comment the Chairman made that should’ve scared the crap out of everyone (my emphasis)…

In prerecorded remarks at a separate conference on Thursday morning, Mr. Powell extolled the example of former Fed Chairman Paul Volcker, who raised interest rates aggressively in the early 1980s to stamp out inflation.

“Chair Volcker understood that expectations for inflation play a significant role in its persistence,” said Mr. Powell. “He therefore had to fight on two fronts: slaying, as he called it, the ‘inflationary dragon’ and dismantling the public’s belief that elevated inflation was an unfortunate, but immutable, fact of life.”

“He had to stay the course,” Mr. Powell said.

We’ll see how the Fed stays the course today…

Make the trend your friend,

Bob Byrne
Editor, Streetlight Confidential