Rising Wages Could Complicate America’s Inflation Cool-Down

Economists have been waiting for Americans to shift from buying goods, like furniture and appliances, and toward spending on vacations, restaurant meals and other services as the pandemic fades, betting the transition would take pressure off supply chains and help inflation to moderate.

Rapid wage growth could make that story more complicated. Demand for services is rising just as many employers are struggling to find workers, which could force them to continue raising wages. While positive for workers, that could keep overall inflation briskas companies try to cover their labor costs, speeding up price increases for services even as they begin to moderate for goods.

Heavy spending on goods during the pandemic has been a driver of the recent inflation burst. Consumers began snapping up items a few months after pandemic lockdowns began and have kept on buying. Spending on services also has recovered, but much more slowly. That shift in what people are purchasing has roiled supply chains, which were not built to produce, ship and deliver so many cars, treadmills and washing machines.

Policymakers spent months betting that as the virus waned and consumers resumed more normal shopping patterns, prices of goods would slow their ascent or even fall. That would pull down inflation, which has been running at its fastest pace in 40 years.

But that transition — assuming it happens — may do less to cool inflation than many had hoped. A big chunk of what the government defines as “services” inflation comes from rental housing costs, which often move up alongside wage growth, as households can afford more and bid up the cost of a limited supply of housing units. And when it comes to discretionary services, like salons and gyms, labor is a major cost of production. Rising pay likely means higher prices.

Jason Furman, a Harvard economist who served as a top adviser to President Barack Obama, said the shortage of workers in many service industries means that if demand for services goes up, prices will too. That means a shift in spending back to services won’t necessarily result in an overall slowdown in the pace of price increases.

“An awful lot of services are incredibly constrained,” he said. “As we shift back to services, we’ll get more services inflation and less goods inflation, and I don’t think it’s at all obvious that the result of that is less inflation.”

While America has gotten used to thinking about shortages in products — couches are out of stock, shoes are back-ordered — labor shortfalls could mean that services will also end up oversubscribed, allowing providers to charge more.

MaidPro, a home-cleaning firm, has seen a surge in demand from professionals who are spending more time at home. But it is having trouble finding workers to keep up, said Tom Manchester, the company’s president.

“Our demand right now outstrips our supply of being able to service that demand,” he said. “Demand has just continued to be strong — like double-digit strong. And if we could find qualified pros to meet the demand, we’d be even more ahead than we are today.”

An Amazon employee delivering packages in Manhattan. Americans have continued to buy goods even as services have rebounded.Credit…Gabby Jones for The New York Times

Mr. Manchester said hourly wages were up $1 to $3, adding to costs at a time when cleaning products have gotten pricier and higher gas prices have made travel reimbursements more expensive. MaidPro franchisees have been able to pass those costs on to their customers, both via fuel surcharges and outright price increases that have more or less kept up with inflation.

So far, they have lost few customers — in part because few competitors have capacity to take on new customers.

Understand Inflation in the U.S.

  • Inflation 101: What is inflation, why is it up and whom does it hurt? Our guide explains it all.
  • Your Questions, Answered: Times readers sent us their questions about rising prices. Top experts and economists weighed in.
  • Interest Rates: As it seeks to curb inflation, the Federal Reserve announced that it was raising interest rates for the first time since 2018.
  • How Americans Feel: We asked 2,200 people where they’ve noticed inflation. Many mentioned basic necessities, like food and gas.
  • Supply Chain’s Role: A key factor in rising inflation is the continuing turmoil in the global supply chain. Here’s how the crisis unfolded.

“If someone has someone that they really like coming in to clean their home, they don’t want to lose them,” he said. “They don’t want to risk saying, ‘I want to move away from MaidPro and try to find someone else,’ because in nine out of 10 instances, that someone else isn’t available.”

Some economists argue that if goods inflation slows, that could still help price gains overall to moderate, even amid rising wages. Prices for products that last a long time rose 11.6 percent in the year through January, and prices for shorter-lived products like cosmetics and clothing were up 7.2 percent, still much stronger than services inflation.

“We have in mind a big decline in goods prices,” said Roberto Perli, the head of global policy research at the investment bank Piper Sandler. “It would take a lot of increase in service prices to actually offset that.”

Outright declines in goods prices are not guaranteed. Take cars: Rapid price growth in new and used autos was a big driver of inflation last year, and many economists expect those prices to dip in 2022. But Jonathan Smoke, the chief economist at Cox Automotive, said continued shortages mean prices for new cars are likely to continue rising, and issues with new car supply could spill over to blunt the expected decline in used car costs.

And services inflation is now also coming in fast. It ran at 4.6 percent in the year through January, the quickest pace since 1989, and it has been posting large monthly gains since autumn. That is enough to keep inflation above the Federal Reserve’s 2 percent goal even if product prices stop accelerating.

While goods have taken up a bigger chunk of household budgets in recent months than they did before the pandemic, Americans still spend nearly twice as much on services as on goods overall.

“You don’t need a lot of extra services inflation to make up for your lost goods inflation,” Mr. Furman said.

Restaurants, hotels and other discretionary services aren’t the only places where persistent demand could run up against limited supply, Mr. Furman argued. Many nonurgent health care services saw a decline in demand during the pandemic and are now experiencing a rebound amid a shortage of nurses and other skilled workers.

Inflation F.A.Q.

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What is inflation? Inflation is a loss of purchasing power over time, meaning your dollar will not go as far tomorrow as it did today. It is typically expressed as the annual change in prices for everyday goods and services such as food, furniture, apparel, transportation and toys.

What causes inflation? It can be the result of rising consumer demand. But inflation can also rise and fall based on developments that have little to do with economic conditions, such as limited oil production and supply chain problems.

Where is inflation headed? Officials say they do not yet see evidence that rapid inflation is turning into a permanent feature of the economic landscape, even as prices rise very quickly. There are plenty of reasons to believe that the inflationary burst will fade, but some concerning signs suggest it may last.

Is inflation bad? It depends on the circumstances. Fast price increases spell trouble, but moderate price gains can lead to higher wages and job growth.

How does inflation affect the poor? Inflation can be especially hard to shoulder for poor households because they spend a bigger chunk of their budgets on necessities like food, housing and gas.

Can inflation affect the stock market? Rapid inflation typically spells trouble for stocks. Financial assets in general have historically fared badly during inflation booms, while tangible assets like houses have held their value better.

Rent — which is the biggest monthly expense for many families and plays a big role in determining inflation overall — has also been rising at a rapid clip. In cities such as Tampa, Fla., Spokane, Wash., and Knoxville, Tenn., listed rents were up by 30 percent or more in the fall from a year earlier, according to data from Apartment List.

Igor Popov, the chief economist at Apartment List, said the breakneck pace of new rent increases is unlikely to repeat itself this year. But many rents will be resetting at higher market rates this spring and summer, he said, adding that they were likely to continue rising as long as wages did the same.

“Rents are partially a function of what people are able and willing to pay,” Mr. Popov said.

The Fed’s recent move to raise interest rates — and its planned increases throughout the year — may cool off the housing market, which could eventually affect rents. But in the near term, higher interest rates might make purchasing homes expensive and out of reach for more people. That could temporarily increase rental demand.

Much hinges on what happens next with wages, and that is anyone’s guess.

Laura Rosner-Warburton, an economist at MacroPolicy Perspectives, said wages might be going through something of a “level reset,” where companies have been paying up in light of a newly tight labor market — in some cases, to get on par with wages at Amazon or other big companies — but may not continue to lift pay so much month after month.

That may be what happened in accommodation and restaurants, she said, noting that both saw a surge in wage pressures that has since cooled off.

Americans still spend nearly twice as much on services — like meals at restaurants — than on goods.Credit…Gabby Jones for The New York Times

Nick Bunker, the director of economic research for North America at the Indeed Hiring Lab, said conditions remain tight — there are 1.8 job openings for every active job seeker today — but the data suggest that labor shortages are no longer actively worsening, which could at least keep wage growth from accelerating further.

“The labor market is stronger, tighter, hotter than it was before the pandemic, but there are some signs that it is starting to level off,” he said.

It is also possible that higher wages will lure workers back into the job market, helping to offset labor shortages and allowing conditions to settle into a more sustainable path.

But the economy has repeatedly surprised economists and businesses over the past year — typically in ways that have stoked pay and inflation.

Mr. Manchester said many maid service executives expected the labor crunch to ease when enhanced unemployment benefits from the federal government ended in September. But while there was some increase in willing workers, there was no sudden flood.

“Everyone is competing for hourly employees,” he said. “We’re competing with the Dunkin’ Donuts, the Home Depots, the Bed Bath & Beyonds — anyone that relies on hourly workers.”

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