In the world’s financial markets, US Federal Reserve chair Jay Powell is increasingly cast in the role of playground bully — looming over the prostrate form of the global economy and chanting “hike, hike, hike” with malicious glee. US policy rates are rising relentlessly.
However, Powell’s public remarks offer little insight into how he expects higher rates to tame inflation. The omission matters as the current policy tightening will have an impact through an unusual route. That is because today’s price inflation is more a product of profits than wages.
Broad-based inflation is normally a labour-cost problem. The rule of thumb is that labour costs are around 70 per cent of the price of a developed economy’s consumer prices. If wage increases are not offset by greater efficiency or reductions in other costs, the consumer will pay a higher price for the labour they are consuming. With normal inflation, central banks would need to create spare capacity in labour markets to push wages lower.