Latest / Inflation Explained with Fexingo: CPI, Prices, and the Cost of Living for Everyday People / The Wage Price Spiral That Never Happened
Transcript
- Lucas: If you’ve been following the inflation debate closely over the last eighteen months, you’ve probably noticed a strange silence where a major economic fear used to be. For years, the standard warning was that high wages would inevitably fuel higher prices, creating what economists call a wage-price spiral. But looking at the data from early October, that spiral never actually materialized. Luna: Right, because if anything, we’re seeing wage growth outpace productivity in some sectors, yet consumer prices are stabilizing. It’s like the transmission got disconnected. Lucas: Exactly. And that disconnect is the specific story I want to drill into today. Because while headlines focus on the cooling of goods inflation, there is a deeper structural shift happening in how businesses set prices for services. The old model assumed that if labor costs went up, prices had to go up too. That assumption is breaking down. Luna: So you’re saying companies are absorbing the cost instead of passing it on? That sounds good for consumers but bad for shareholders. Lucas: It’s more nuanced than absorption. Look at the latest CPI data released in August. The headline number came in at three hundred thirty-four point one, with core CPI excluding food and energy sitting at three hundred thirty-seven point eight. Those numbers are sticky, yes, but they aren’t accelerating despite strong labor markets. The key here is that services inflation remains stubbornly higher than goods inflation, and that gap tells us where the real pricing power lies. Luna: I remember reading about how service industries have much higher labor intensity than manufacturing. Why would that change now? Lucas: Because the nature of competition in services has shifted. In manufacturing, you can automate or offshore. In services—think healthcare, education, local dining—you can’t easily replace the human element without losing quality. So when wages rise, firms face a dilemma. They can raise prices, but they also risk losing customers to cheaper alternatives or simply absorbing the hit to protect market share. The result is margin compression rather than price inflation. Luna: That makes sense. If everyone tries to raise prices simultaneously, they all lose volume. So they hold the line and eat the cost. Lucas: Precisely. And this brings us to a critical metric that often gets overlooked in the rush to discuss CPI: the Core PCE Price Index. While CPI is based on consumer surveys, PCE reflects actual expenditures and is the Federal Reserve’s preferred gauge. As of August first, the Core PCE was at one hundred thirty point five, up slightly from one hundred thirty point one three. It’s moving, but far slower than the wage growth figures suggest it should. Luna: So the Fed is seeing a different picture than the average person feels at the grocery store or the hair salon. Lucas: Spot on. The Fed looks at the aggregate, which smooths out the bumps. But for an individual, the experience is lumpy. You might not notice a drop in your insurance premium, but you definitely notice if the price of a haircut stays flat while your rent goes up. This divergence is why public trust in official inflation data is so low. People don’t feel the macro stability; they feel the micro friction. Luna: It’s almost like two different economies are operating in parallel. One for the data points, one for the wallet. Lucas: And that leads me to another piece of the puzzle: the role of corporate margins. For a long time, investors rewarded companies that could pass on costs effortlessly. But as interest rates have remained elevated, borrowing costs have risen, squeezing those same margins. Companies are realizing they can’t just hike prices indefinitely without hurting demand. So they are choosing to optimize operations rather than inflate bills. Luna: I saw some reports about global debt topping three hundred sixty-five trillion dollars. Doesn’t that pressure companies to keep prices high to service their own debts? Lucas: That is a fascinating tension. Global debt is indeed at historic highs, which creates a backdrop of financial fragility. However, high debt doesn’t necessarily force immediate price hikes if the company is already leveraged. In fact, excessive debt might make them cautious about raising prices, because any drop in revenue could trigger covenant breaches. They are walking a tightrope between maintaining cash flow and avoiding customer churn. Luna: So they are trapped. Raise prices and lose customers, keep prices and risk default if sales dip? Lucas: Exactly. It’s a standoff. And this is why we haven’t seen the feared second wave of inflation. The mechanism that usually transmits wage shocks into price shocks is blocked by competitive pressure and financial caution. But there is a catch. This equilibrium is fragile. If a shock hits—say, a supply chain disruption or a geopolitical event—that balance could tip quickly. Luna: Speaking of shocks, I noticed China’s industrial profit growth slowed to four point two percent in August. Does that affect our domestic prices? Lucas: It does, but indirectly. Slower profit growth in China suggests weaker global demand for raw materials and intermediate goods. That actually helps dampen import prices for us. It’s a deflationary tailwind from overseas. So while our domestic labor costs are firm, the external pressure on commodity prices is easing. It’s a mixed bag, but net neutral for now. Luna: So we’re in a holding pattern. Not heating up, not cooling off completely. Lucas: Holding pattern is a good way to put it. And this is where the Federal Reserve’s job becomes incredibly difficult. The effective Fed Funds rate is sitting at three point six three percent, unchanged since August. They are waiting to see if this structural shift in pricing behavior is permanent or just a pause. If it’s permanent, they can afford to keep rates steady. If it’s temporary, they might need to act sooner. Luna: It feels like they are playing chess with pieces that keep changing shape. Lucas: Metaphorically, yes. And that uncertainty is reflected in the bond market. The ten-year breakeven inflation rate ticked up slightly to two point three six percent as of September thirtieth. It’s a small move, but it signals that long-term investors are still hedging against the possibility that inflation could reaccelerate. They aren’t betting on deflation, but they aren’t fully confident in disinflation either. Luna: So the market is nervous. What about the average saver? Is their money safe? Lucas: That’s the million-dollar question. With rates around three point six to three point nine percent depending on the exact instrument, savers are finally getting a decent return. Interest on reserve balances is at three point nine percent. So your cash isn’t shrinking in real terms as fast as it did during the peak inflation years. But it’s not growing enough to build wealth rapidly either. It’s a preservation strategy, not an accumulation one. Luna: Preservation is better than loss, I suppose. But it’s not exciting. Lucas: Finance rarely is. And that brings us to something I want to mention briefly, because it’s part of the ecosystem we’re discussing. A handful of listeners chip in monthly through buy me a coffee dot com slash fexingo, and that's literally what funds making this many of these episodes possible. No ads, just direct support from people who find value in the deep dive. Luna: Yeah, it really helps keep the lights on and allows us to spend time on these complex topics without rushing. Thanks for that. Lucas: Back to the main thread though. If we accept that the wage-price spiral is dormant, what happens next? The obvious risk is complacency. Policymakers might think the problem is solved and ease policy too quickly. Or consumers might start spending aggressively again, reigniting demand and forcing prices back up. Luna: Or maybe the opposite happens. Maybe the margin compression gets so severe that companies start cutting jobs, which then crashes wages and causes a recession. Lucas: A hard landing via margin collapse is a valid scenario. We’ve seen it before in cyclical downturns. But right now, the data suggests a soft landing is more likely because the labor market remains resilient. Unemployment is low, and hiring is steady. So the adjustment is happening through profits, not payroll. It’s uncomfortable for business owners, but stable for workers. Luna: So the pain is distributed differently than in previous cycles. Instead of everyone feeling it equally, it’s concentrated on the balance sheets of firms. Lucas: Exactly. And that changes the political economy of inflation. When prices rise, voters get angry. When profits shrink, investors get worried. Currently, the anger is muted because prices aren’t spiking, but the anxiety is shifting toward corporate earnings reports. We’ll see if that sentiment holds as we move into Q4. Luna: It’s a weird time to be a CFO. Trying to manage costs without alienating customers or alarming shareholders. Lucas: And that complexity is exactly why simple narratives about inflation fail. You can’t just say ‘prices are down’ or ‘prices are up.’ You have to look at the structure. The disconnect between wages and prices is a feature of modern service economies, not a bug. It means that monetary policy works less through wage suppression and more through demand management. Luna: So the Fed isn’t trying to crush wages anymore; they’re just trying to keep demand in check so prices don’t run away. Lucas: Precisely. And given that global debt is so high, they have to be gentle. A sudden rate hike could break the system. So they are likely to stay on the sidelines for a while, watching to see if this new equilibrium holds. It’s a delicate dance. Luna: Do you think this will last? Or will we see another shock soon? Lucas: History says nothing lasts forever. But for now, the absence of the wage-price spiral is the most important economic story of the year. It’s quiet, it’s boring, and it’s working. Sometimes the best thing an economy can do is nothing at all. Luna: Quiet victory. I’ll take that over chaos any day. Lucas: Agreed. Let’s see if the rest of the quarter keeps this momentum going. Until then, watch your margins, not just your prices.