Analysis of Inflation Persistence
Introduction:
The persistence of inflation poses challenges for policymakers and researchers. However, this is not a new phenomenon and has been well-documented since the 1930s. By analyzing U.S. core CPI inflation data, it is clear that inflation persistence can last for almost a year, with statistically significant lags.
Traditional Models Explaining Price Stickiness:
Traditionally, well-established models have explained price stickiness by categorizing them into four types based on market imperfections in the labor or goods market and whether markets are clear. These models include the worker-misperception model, imperfect-information model, sticky-wage model, and sticky-price model.
Challenges to Traditional Models:
However, in the current AI and big data era, market imperfections have been greatly reduced, if not eliminated entirely. The assumption of markets not clearing is also less common in popular general equilibrium models. While pricing can be adjusted relatively quickly, wages cannot due to standard labor contracts that rarely allow for wage reduction. As a result, wage stickiness becomes a crucial factor in explaining price stickiness.
The Wage-Price Spiral Hypothesis:
The wage-price spiral hypothesis plays a vital role in linking wage stickiness to price stickiness. If established, it would explain how inflation persistence is connected to unemployment stickiness, which aligns with the Phillips curve framework.
Examining the Wage-Price Spiral:
To assess the presence of a wage-price spiral, we can refer to the U.S. Wage-Price Spiral chart. The blue line represents the year-over-year growth in hourly earnings, while the red line represents year-over-year CPI growth for services only. Focusing on services inflation is important as it constitutes 64 percent of the overall basket and is highly resistant to change.
Observations from the Chart:
1. Services inflation remains high at 5.2 percent.
2. The commovement of price growth and wage growth suggests well-anchored inflation expectations.
3. Hourly earnings growth and services inflation have been at similar levels since the mid-1990s, indicating a quarter-century of consistency.
4. Clear uptrends for both hourly earnings growth and services inflation since 2010 indicate persistent inflation pressure.
Implications for Future Inflation:
With the high base period passing, upcoming months are likely to see higher inflation rates than in recent times. While earnings inflation is slowing down to 4 percent, services inflation is expected to maintain a similar level, thus contributing to an overall inflation rate of around 4 percent for the foreseeable future.
Conclusion:
The analysis of inflation persistence reveals that wage stickiness plays a significant role in explaining price stickiness. The wage-price spiral hypothesis provides a framework for understanding the link between unemployment stickiness and inflation persistence. The U.S. Wage-Price Spiral chart demonstrates the consistency of hourly earnings growth and services inflation over the past few decades, indicating persistent inflation pressure. This analysis has important implications for policymakers and researchers as they navigate the complexities of managing and understanding inflation in the modern era.
