A Future Burst of Wage Hikes Will Lift Inflation, Economist Predicts

While pay raises are torpid now, expect a surprise at year-end due to tight labor markets, David Levy says.

So, inflation is not such a big deal, huh? Economist David Levy begs to differ. The US will experience an “inflationary shock” toward year-end, as prices jump propelled by wage gains, he wrote in his firm’s June report.

Most investors foolishly believe that wages won’t rise much, interest rate increases will be moderate, and inflation flat or marginally higher, contended Levy, chairman of the Jerome Levy Forecasting Center. “This scenario is a fantasy,” he declared.

“The market seems to be badly underestimating how fast the hot economy can overheat and how hot it can get,” he stated.

Certainly, wage growth thus far hasn’t exactly been spectacular. Headline inflation picked up recently, hitting 2.8% on an annual basis in May, but as Levy pointed out, much of that was due to energy price escalation. Nominal pay was up 2.7% annually, which meant that inflation eroded much of that gain.

But unemployment has fallen to a low 3.8%, meaning that more robust raises are in the offing, Levy reasoned. Today’s tight labor market will increasingly demand them, he said.  That’s hard to detect right now. He noted that, in the current economic cycle, suspended pay boosts and bonuses in the early part of the recovery lowered base wages—and set the stage for years of stagnation.

Still, Levy asked, what happens if the jobless rate gets near 3%? Then the pressure will really be on to fatten paychecks, he wrote.

The story of this economic expansion has been one of slow moves, of the Federal Reserve’s gradually pushing up interest rates, of a slow decline in unemployment, and of inflation inching upward, though still mired in the low single digits.

Levy, however, recounted how his father, S. Jay Levy (Jerome was David’s grandfather), in the mid-1960s forecasted the spiraling inflation that was to bedevil the 1970s. S. Jay Levy noticed that hourly wages, which had long gone up at a 3% yearly pace, began accelerating in 1966, and reached 6% in short order.

In David Levy’s experience, most people fail to realize that labor costs don’t advance in a linear fashion. In time, he wrote, “pay rates that have been climbing slowly can suddenly rise faster within a quarter or two,” startling the Fed, companies, and the market.

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