Companies and Workers Risk Persistent Inflation by Passing Inflationary Shocks Onto Each Other

According to the Bank of England’s Chief Economist, Huw Pill, companies and workers are reluctant to accept that they are worse off due to inflation and are trying to pass the impact of inflation onto each other. This behavior risks persistent inflation. In an episode of Columbia Law School and the Millstein Center’s “Beyond Unprecedented” podcast, Pill explained that passing the cost of inflation onto one’s compatriots is like playing a game of pass the parcel that generates inflation.

Inflationary Shocks Fueling Inflation

Pill discussed the “series of inflationary shocks” that have fueled inflation over the last 18 months. These shocks include pandemic supply disruption, government household support programs boosting demand, the Russian invasion of Ukraine and resulting spike in European energy prices, adverse weather, and an outbreak of avian flu driving up food prices.

Self-Defeating Process of Wage and Price Setting

Pill acknowledged that it was “natural” for the behavior of price-setters and wage-setters in economies, including the U.K. and U.S., to change when living costs such as energy bills rise. Workers would ask for higher salaries, and businesses would raise prices. However, this process is ultimately self-defeating. Pill added that the U.K., which is a net importer of natural gas, faces a situation where the goods it buys from the rest of the world have gone up a lot relative to what it is selling to the rest of the world, primarily services. The U.K. imports nearly half its food. Therefore, someone in the U.K. needs to accept that they are worse off and stop trying to maintain their real spending power by bidding up prices, whether higher wages or passing energy costs through to customers.

The concept of a wage-price spiral, when rising wages create a loop of inflationary pressures by increasing costs for businesses and boosting demand, is debated within economics. Some policymakers do not see evidence of it in the U.S. or euro zone. However, some argue that the U.K. is particularly at risk of a wage-price spiral contributing to “stagflation” due to its import-heavy economy, weakness in the British pound, a tight labor market constrained by Brexit, and years of stagnant wage growth.

In March, U.K. inflation was expected to drop into the single digits but came in at 10.1%, with core inflation, which excludes food and energy and is closely watched by the Bank of England, at 5.7%.