Economics
Inflation, and central banks’ response to inflation, are having unforeseen consequences.
Your boss isn’t going to give you a pay rise: find another job
In defiance of economists’ simple models, which predict that a shortage pf labour and a low unemployment rate should result in rising wages, wage growth in Australia is very low – in fact negative in real (inflation-adjusted) terms.There are explanations involving falling union membership, the inherent stringency in the awards system, and the weak position of public sector workers employed by budget-constrained state governments. But these do not reveal why wages growth has been subdued for so long. Even though labour productivity has been low and declining in recent years, for a long time wages growth has lagged productivity.
The Treasury Department’s Jonathan Hambur has looked into the possibility that concentration in key Australian industries may be a contributing factor to our low wage growth. With his colleagues he has written a Treasury Working Paper Did labour market concentration lower wages growth pre-COVID?.
His research covers the period 2005 to 2016 which precedes both Covid-19 and the period of stalled productivity growth. Productivity was rising, and after the shock of the 2008 Global Financial Crisis unemployment was falling. Therefore wages should have been rising in line with productivity.
But they were not.
Hambur finds that lower unionisation provides a partial explanation. But the dominant causal factor is industry concentration. We may not have many industries dominated by monopolies, but there are many industries where oligopoly is the general pattern, such as airlines and large supermarkets. If an industry is an oligopoly in relation to its customers, it is likely to be an oligopsony (a powerful buyer) in relation to its employees and suppliers. Unsurprisingly wages growth has been higher in less concentrated industries.
He does not find that firms’ power in the labour market has strengthened over time, however. Indicators of market concentration have not changed very much. But he does find employees have become less mobile over time – less likely to switch location and less likely to switch occupation.
His findings are consistent with a labour market in which people win wage rises through switching jobs, and they can do even better through switching occupation if they can. That is more rewarding than hanging around and waiting for the boss to offer a pay rise. But in industries with little dynamism, where there are few new firms opening up, such opportunities are not always available.
How the IMF and other clever people missed the inflation surge
Should the IMF – and by extension the world’s bankers and policymakers – have seen the world inflationary surge coming?
That is the subject of an article in the IMF Finance & Development journal by Christoffer Koch and Diaa Noureldin of the IMF’s Research Department: How we missed the recent inflation surge.
The pandemic and Russia’s invasion of Ukraine have thrown previous forecasts out of line, but there were developments that could have been recognized. First, fiscal responses to the pandemic were probably based on over-estimates of the pandemic’s reduction of production and were therefore too stimulatory. (Maybe that is not so relevant for countries that took strong public health measures such as Australia.) Second, supply-chain shocks took policymakers by surprise: the world’s supply chains have become more finely tuned and lacking in redundancy over recent times. Third, demand-supply imbalances were amplified by a shift in demand from services to goods. And fourth, there was unprecedented labour market tightness (particularly relevant for Australia).
The authors’ focus is on fiscal policy. While Australia had a fiscal boost, we also had a strong monetary boost resulting from the Reserve Bank having held down interest rates for so long.
The ABC’s Gareth Hutchens has a summary of the work by Koch and Noureldin, along with references to those who commented on other signs of inflation, particularly surging profits. Hutchens’ chart comparing IMF inflation predictions with inflation outcomes is striking for all countries. For Australia the gap between the inflation prediction and the outcome, at 4.1 percent, is close to the world’s lowest.
Bank collapses in the Silicon Valley and Switzerland: runs contained, but there’s still damage
When a bank fails two competing forces come into play. One is contagion, particularly in the US which, in comparison with Australia, seems to have a different bank on every street corner. If one bank goes everyone gets jittery about the safety of their deposits: the domino theory may not have held for the supposed spread of communism in southeast Asia, but itholds for banking.
The countervailing force is the voice of government, and the banking community in general, trying to stop a run of withdrawals.
No run on the Bank of NSW at Taralga
The SVB collapse has happened at the same time as other US bank collapses, and shortly before Credit Suisse ran out of cash. Governments’ soothing voices may not have been sufficiently convincing to protect against contagion. A fair bit of attention has been paid to the collapse of New York’s Signature Bank, but their circumstances are different. Signature Bank was over-invested in crypto assets, while SVB’s problem was a cash-flow problem.
As William Chittenden of Texas State University puts it in a Conversationpost, the immediate answer is that “SVB did not have enough cash to pay depositors so the regulators closed the bank”. You can’t get a more basic explanation than that.
He goes on to explain that because SVB had raised more money from depositors than it could lend to investors, it invested the balance in bonds, at a time when interest rates were low, but as a result of recent rises in interest rates their value has fallen and the bank was left with a cash shortage when these bonds had to be sold to pay withdrawals.
The ABC’s Ian Verrender has a neat explanation of how accounting standards used by banks can overstate the value of bonds in an environment of rising interest rates. The longer their time to mature, the less is their coupon value likely to correspond to their market value. SVB’s misfortune has undoubtedly led to investors looking more carefully at all banks’ balance sheets, possibly explaining the tumble in the share price of Credit Suisse.
In a short (6-minute) explanation on ABC Breakfast, Yesha Yadav of Vanderbilt Law School presents much the same analysis as Chittenden, but he goes on to suggest that SVB’s failure has sent jitters worldwide among banks that have invested heavily in high-tech startup companies. Their balance sheets have heaps of high-risk investments.
Banks are likely to become more conservative in their lending, passing on to borrowers not only higher baseline interest rates, but also a higher risk premium, raising the cost of finance higher for startups and young high-tech companies. Kelli María Korducki, writing in The Atlantic, suggests that Silicon Valley is losing its luster. Republicans, however, are blaming SVB’s collapse on wokeness – nonsensical but an easy attack to make against a company that took seriously its social and environmental responsibilities.
As far as Credit Suisse goes, its problems seem to relate to its own long-term problems – its share price has been falling for a long time. But there is likely be a contaigon of caution, which will see banks worldwide apply higher risk premiums to their lending, making the cost of capital a little higher for all borrowers.