Wage-price spiral fears to dictate Fed’s policymaking, says UI professor

One University of Iowa professor expects the Federal Reserve will raise interest rates and ensure inflation decreases to avoid the devastating impacts of a wage-price spiral. A wage-price spiral is when inflation and high demand causes the price of goods to increase, prompting workers to demand higher wages to offset their loss in purchasing power. Considered a perpetual loop, company's expenses go up and cost of goods yet again, resulting in the process to repeat itself. To avoid inflation getting out of control quickly, the Federal Reserve is determining how to best restore price stability without inducing a recession, said Anne Villamil, an economics professor with the Tippie College of Business, during a webinar titled 'The State of the Macroeconomy.' "If we got this wage-price spiral, that would be very, very concerning," Ms. Villamil answered to an audience member. "And the Fed will jump on that. The Fed has the ability to tamp that down. The way to do that is to raise interest rates. It's clearly signaling that to the market, and the market clearly believes that. If the Fed is behind this curve, then a wage-price spiral could take over. If it is too aggressive, it could throw the economy into a recession. That's why there is risk of a policy mistake." "I expect inflation is going to decline one way or another," she added. "We are not going to persist with inflation of 7%. The Fed simply won't permit it. So there's no doubt in my mind that inflation is going to come down because the Fed does have the tools to deal with it." The U.S. rate of inflation climbed again to a 40-year high in January to 7.5%, according to the latest consumer price index report released Thursday. The Core Consumer Price Index, that removes volatile food and energy prices from the measurement, also saw inflation rise by 0.6% last month. The Federal Reserve prefers for the inflation rate to hover around 2%, and experts expected Thursday's report to show inflation at 7.3%. The higher-than-expected inflation rate caused the Dow Jones Industrial Average to drop more than 400 points. It is expected the Federal Reserve in March will raise interest rates for the first time in four years. While the Federal Reserve could choose to employ the "shock and awe" approach by raising interest rates dramatically instead of over time, there is concern that would cause a recession, Ms. Villamil said. Dealing with the effects of COVID-19 The recession spawned from the COVID-19 crisis was the sharpest seen since the 2008 financial collapse, but the recovery took just two quarters and was the shortest recession on record in the U.S., she explained. That is partly due to massive policy intervention such as the Federal Reserve decreasing interest rates to zero and the government rolling out Paycheck Protection Program loans. Months later, the government sent stimulus checks to eligible individuals. This led the United States to become one of the first countries to recover from the economic pandemic slowdown. These policies, known as running the economy hot, helps stimulate the labor market, keeps a maximum amount of the population employed and is specifically designed to help less skilled workers. After skyrocketing to 15% unemployment in 2020, the U.S. unemployment rate is nearing pre-pandemic levels. Still, firms are having trouble finding workers, with many women leaving the workforce, as well as individuals aged 55 years and older, said Ms. Villamil. Some workers found their job to be unfulfilling or could not return to work immediately due to child care troubles or health concerns, whereas other workers have been empowered to demand wage increases. Deere workers chose to utilize their bargaining power by striking and then negotiating a new labor agreement for improved wages and benefits.