In September, the consumer price index (CPI) was 8.3 percent higher than a year ago, and core inflation, which excludes the volatile energy and food components of consumer spending, printed at 6.3 percent. Clearly, one of the most important causes of America’s inflationary surge has been skyrocketing oil and food prices, which not only boost the “headline” CPI figure but bleed into core inflation as well. Beyond that, the pressure of rising aggregate demand, particularly the tightness of labor markets, has been a key factor pushing up core prices.

Rising job vacancies have been widely cited as an indicator of this tightness, and these vacancies have indeed soared since the beginning of the COVID-19 pandemic. The coincidence of rising job vacancies with rising inflation may seem to suggest a standard wage-price Phillips curve story, with overheated labor markets leading to higher wages that boost labor costs and force companies to charge higher prices. Federal Reserve Chair Jerome Powell referenced this story in a recent press conference. He said:

“It seems as though by moderating demand, we could see vacancies come down and, as a result—and they could come down fairly significantly and, I think, put supply and demand at least closer together than they are. And that would give us a chance to get inflation down, get wages down, and then get inflation down without having to slow the economy and have a recession and have unemployment rise materially.”

But is this “Phillips curve” story of the ongoing pandemic inflation surge correct? Is higher inflation the result of tight labor markets that in turn lead to higher wage growth and thus higher price inflation? The evidence for this view is mixed at best.

Between the fourth quarter of 2019 and the second quarter of 2022, wages rose 10.9 percent, but the CPI rose 13.7 percent. This indicates that other costs besides wages – notably, prices of food and energy – have been rising faster than wages. These prices are set in global markets, and we would not expect them to be much affected by labor markets and wages in the United States. If we exclude prices of food and energy, the core CPI rose 10.2 percent over the same period, suggesting that wages were roughly keeping up with core inflation, not leading it.

Considering that other costs besides wages figure into the pricing of goods and services, if rising wage growth had been the only driver of the surge in core inflation, it would have exceeded inflation by a greater margin. Indeed, costs of shelter (e.g., rent and owners’ equivalent rent), which account for about 40 percent of the core CPI, rose 9 percent between the fourth quarter of 2019 and the second quarter of 2022, but little of this likely owed to rising wages.

In research with my colleague John Kearns, we shed additional evidence on the links among job vacancies, wages and core inflation by examining the experience of other advanced economies. We asked: Have economies with larger increases in wages since the beginning of the pandemic experienced larger increases in core inflation? We found the answer is no. Although there is a strong correlation between job vacancies and core inflation across countries, there is only a tenuous correlation between nominal wage growth and core inflation. 

What may explain this conundrum? In our view, job vacancies reflect excess demands for goods and services, and these could be driving up corporate markups as well as input prices, wages, rents and other costs of doing business. Those excess demands are the result of several factors, including heavy fiscal outlays earlier in the pandemic, spending out of large household savings also accumulated during the height of the pandemic and, on the supply side, reductions in labor force participation.

An implication of our findings is that a rise in unemployment and a decline in wages may not be a necessary condition to bring inflation under control. As several Federal Reserve officials have argued, it may be possible for vacancies to fall without large increases in the unemployment rate. Such a reduction in excess demand for goods and services could reduce upward pressure on prices without requiring much in the way of layoffs and unemployment.

Whether such a soft landing is possible, however, remains uncertain. To begin with, our finding does not diminish the need for the Fed to tighten monetary policy to lower spending and restrain inflation, so some rise in unemployment and slowdown of wages may be unavoidable collateral damage to cool an overheated economy.

Furthermore, even if wage growth has not been the primary driver of inflation so far, it could become the primary driver going forward if inflation expectations rise or workers attempt to reverse prior losses in real wages. In such circumstances, monetary tightening again may be needed to contain inflation expectations, wages and prices.

Steven Kamin is a senior fellow at the American Enterprise Institute (AEI), where he studies international macroeconomic and financial issues.

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