“Since the COVID slump, labour’s share of income and real wages have been falling sharply even as unemployment falls. This is the complete opposite of the Keynesian inflation theory and the so-called ‘iron law of wages’ proposed by Weston against Marx. The rise in inflation has not been driven by anything that looks like an overheating labour market—instead it has been driven by higher corporate profit margins and supply-chain bottlenecks. That means that central banks hiking interest rates to ‘cool down’ labour markets and reduce wage rises will have little effect on inflation and are more likely to cause stagnation in investment and consumption, thus provoking a slump.
The BIS summed up this debate: “In product markets, the degree of competition comes into play. Firms with higher markups – an indication of greater market power – could raise prices when wages increase, while those without such pricing power may hesitate to do so. Strategic considerations in price-setting are also relevant. Firms may feel more comfortable raising prices if they believe their competitors will also do so. Price increases are more likely when demand is strong. With less concern about losing sales and less room to adjust profit margins, even firms with less pricing power could pass higher costs through to customers.”“
The Governor of the Bank of England, Andrew Bailey set the attitude of the mainstream view on the impact of inflation in February, when he said that “I’m not saying nobody gets a pay rise, don’t get me wrong. But what I am saying is, we do need to see restraint in pay bargaining, otherwise it will get out of control”.
Bailey followed the Keynesian explanation of rising inflation as being the result of a tight (‘full employment’) labour market allowing workers to push for higher wages and thus forcing employers to hike prices to sustain profits. This ‘wage-push’ theory of inflation has been refuted both theoretically and empirically, as I have shown in several previous posts.
And more recently the Bank for International Settlements (BIS) study confirms that “by some measures, the current environment does not look conducive to such a spiral. After all, the correlation between…
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