Shocks Versus Trends

Today, I’ll take a break from focusing on the labor market to look at a related, but shorter-term issue—shocks versus trends. This topic has current relevance, as well as wider applicability, so it is worth thinking through.

What sparked my attention? I have been getting questions as to whether the recent spike in inflation—which is real—implies a change in the inflation trend going forward. That’s not necessarily true, although this post will look closely at trends we may see over coming months. Whether the current inflation spike is a signal of change is a separate and interesting question.

Positive Shocks to Real Income

Let’s come at this topic another way, since most of what we’re talking about relates to jobs. Suppose you have been working at a job for some time, and you are receiving annual raises in line with inflation. So far, so good. Then, one day, you get a call from a recruiter regarding a new job. The company is offering a signing bonus, as well as a significantly higher salary. Does that mean you will be making more going forward?

You will certainly get a significant bump in income the first year, given the signing bonus and higher salary. Going forward, you may make more every year, but only by the difference in your salary, as the signing bonus was a onetime event. But that raises a pertinent question: Did you negotiate future salary increases—raises in excess of inflation—as part of your deal? Most people do not. Generally, negotiations are focused on maximizing starting salary and benefits, with the expectation that future increases will be in line with inflation or the market. In other words, the jump in purchasing power with respect to inflation that you will realize is a onetime deal. It will not be repeated in subsequent years of employment. The salary increase is a (positive) shock to your real income, not a change in trend.

Return to Equilibrium

That example is a very good match for where workers find themselves right now. The same goes for the economy as a whole. We got a signing bonus, a onetime payment, in the form of the stimulus checks and enhanced unemployment benefits received due to the pandemic. The benefits of these payments are expiring and will not be back. Many workers are now looking for a raise, as they switch jobs or as their companies raise pay to keep people. Workers are trying to get as much as they can right now. Companies are looking to pay as little as they think they can get away with. The balance between these factors will determine just how much of a raise the economy as a whole will get. But that does not mean we will see this same thing happen again next year, or the year after that.

Think about it. Once the economy moves back into balance, with the labor market and everything else, there will be no need for disruptive shocks. Once the job seekers find new employment, and workers move back into the labor force to fill the vacant jobs, wages will return to equilibrium. Going forward, workers won’t be able to find new jobs at significantly higher pay because employers will have the labor they need.

Short- and Longer-Term Outlook

Of course, labor market balance depends on enough workers being available. In the short term, this scenario looks likely. In the longer term, continued balance looks less likely, which could create a systemic push for higher wages over time. That outcome is quite possible, but not in the short term.

In the short term, that onetime bonus (in stimulus and benefits) and the onetime raise (as people get new jobs) will push demand up. Increased demand will create—and is creating—inflation. We are seeing that right now. But what this scenario will not necessarily do is change the trend in inflation after the onetime bump is gone. Right now, inflation in the job market and elsewhere is a shock that will pass. Wages will be left at a higher but stable level. Longer term, we could well see a change in trend—but we are not there yet.