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Wednesday, December 1, 2021

Britain is doomed to either an inflation trap or a squeeze on incomes

But just because wages are rising, this does not mean that the inflation is, in the old language, “cost-push”, as opposed to “demand-pull”, even if it appears that the rise in wages comes before the rise in prices.

Excessively strong aggregate demand manifests itself in the labour market as much as in the product market. Even devotees of monetarism can point to rapidly rising wages as vindication of their earlier warnings of high inflation ahead based on large increases in the money supply. 

So what is happening with pay inflation now? We cannot be sure. The most we can do is make an educated guess. We do know that productivity growth is extremely difficult to shift. It depends crucially upon investment, the progress of technology, and the efficiency with which new products and processes are deployed.

These things do not change very rapidly. For much of the post-war period, UK productivity growth averaged about 2.5pc, with real wages growing at about the same rate. But recently productivity growth has been disappointing. Over the last 20 years, according to the official data, it has been running at about 1pc per annum. 

So what rate of pay growth signals inflationary danger ahead? If the rate of productivity growth were to run at about 2pc per annum, then wage growth of 4pc per annum would be consistent with achieving the 2pc inflation target.

But if productivity growth were only 1pc per annum, then consistency with the inflation target would require that on average pay should be increasing at only about 3pc per annum. 

Over the last two years all economic statistics have been polluted by the effects of the pandemic and associated lockdowns, making them extremely difficult to interpret. The headline rate of increase of average earnings went from about 4pc before the pandemic down to minus 1pc at the nadir, followed by a climb up to about 9pc in June, before falling back to just under 6pc now.

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