October: CPI Inflation Continues to Exceed Wage Growth

Today, the Bureau of Labor Statistics (BLS) released the latest data on its Consumer Price Index (CPI), showing a monthly rise of 0.44% in October, which translates into an annualized rate of 5.4%.  This is actually up slightly from September, when the monthly rise translated to an annualized rate of 4.7%. Meanwhile, the year-over-year increase was 7.8% in October, down slightly from the 8.2% reading in September. 

It goes without saying that the year-over-year annual inflation measure of 7.8%, or the one-month change (annualized) of 5.4%, are still far above the Federal Reserve System’s announced target of 2% inflation. 

On the wage front, the BLS reports that average hourly earnings of private sector workers increased by 0.37% in October, an annualized rate of 4.5%.  Over the last twelve months, wages have increased 4.7%. 

The good news for workers is that wages have been mostly keeping up with price rises since mid-summer.  Real wages reached a low in June 2022, then increased in July, and slightly increased in August, before resuming slight declines in September and October.

Still, inflation-adjusted (or ‘real’) wages decreased in October by 0.07%.  Inflation-adjusted wages are down over the past twelve months by 2.8%.

Taking a longer perspective, wages are up 8.9% since January 2021, but prices are up 13.7%, leaving workers with 4.2% less purchasing power.  Currently, the labor market also remains very tight, perhaps surprisingly so given the decline in real wages.  The October unemployment rate was 3.7%, up slightly from September’s 3.5% but equal to the reading from August, and still well below the Federal Reserve’s projection of 4% as the long run full employment rate corresponding with its 2% inflation target.

How did we get into this situation?  In part it is due to the Fed’s new policy framework.  The Fed undertook a widely publicized review of its monetary policy strategy in 2019 and 2020, and announced adoption of a new framework in August 2020.  There were several changes to the prior framework that had served us well over decades.  One was the Fed’s change from a 2% inflation target to a 2% average inflation target.  This means that the Fed would allow inflation to be ‘moderately’ higher than 2% ‘for some time’ to make up for a period of time in which inflation had run below 2%.  Perhaps more importantly, the Fed would no longer move preemptively to deal with signs of possible future inflation, but instead would wait to actually see inflation emerge before responding.

Well, the Fed did appear to wait before responding to our rising inflation rate, it did let the genie out of the bottle, and we are now relearning the painful lessons of the past: that it is easier to let the genie out than to get the genie back in the bottle.  There is a reason why for many years the Fed acted preemptively to tighten policy in anticipation of incipient inflation. 

William McChesney Martin, Fed chair from 1951-1970, famously said ‘The Federal Reserve … is in the position of the chaperone who has ordered the punch bowl removed just when the party was really warming up.’  It seems the Fed did not follow this dictum in 2021.

The graph below shows that annualized monthly inflation measures were above 2% every month of 2021, and the year-over-year inflation measures rose above 2% by March of that year.  At the same time, the Fed infamously labeled this inflation as transitory and waited until March of 2022 to first raise its policy rates.  To summarize, the Fed missed its 2% target for a year, and by substantial amounts, before responding. 

The graph also shows that the annualized monthly inflation measures, while noisy, seem to have declined in recent months.  These annualized measures actually fell below 2% in July and August as energy prices declined.  Since then, the annualized monthly measures have risen to the 5% range for September and October, well above the 2% target and suggesting that inflation is still way too high, even as it has declined below those March and June peaks.

It remains to be seen how the Fed will regard overshooting compared to undershooting its inflation target.  In announcing its new policy framework, it specifically mentioned having inflation above 2% to make up for previously being below target.  They might want to make clear that this is an asymmetric policy prescription.  I doubt they plan to have inflation below 2% in coming years to make up for currently being so far above their target.


Posted: November 10, 2022 by Dennis W. Jansen