There is a widely held assumption that with US wages on the rise, we should expect some cost-push inflation to materialize.

In fact, however, despite a record low 3.7% unemployment rate, it is very difficult to detect any evidence of cost-push inflation affecting consumer prices.

Indeed, and after picking up steam earlier in the year, consumer prices seem to be moderating again as evidenced by the core PCE inflation rate dropping in October to 1.8% year-on-year, or below the Fed’s 2% target.

(Core inflation in the US is measured by both by the core Consumer Price Index and the core Personal Consumption Expenditures price index. The Fed prefers to use the PCE price index because it provides a better indication of underlying inflation trends than the core CPI.)

Recently the US consumer price index (i.e. the CPI) remained unchanged in November from the October level due to a sharp decline in gasoline prices. As of the 12 months ending November, the all items CPI rose 2.2%, slowing from October's 2.5%.

Over the same 12 months ending November, the so-called core CPI increased 2.2% after climbing 2.1%.  

Nonetheless, as pointed out earlier in this article, the Fed’s favorite inflation target is the core PCE inflation rate, which dropped in October to 1.8% year-over-year, which is lower than the Fed’s 2% inflation target.

As the following chart illustrates, the core PCE’s more recent trends should be concerning to the Fed since the three-month annualized rate sank to just 1.1%, the lowest since May last year.

In unpacking the various factors that affect the rate of inflation, it has always been thought that for inflation to be sustained, it needs to be validated in the labour market.

However, since the great financial meltdown nearly ten years ago wage inflation in virtually in all advanced economies has been extremely low, despite the fact that the job markets measured by conventional measures, has tightened considerably in recent years.

There are short-term determinants to consumer price movements and then there are the more longer-term determinants.

Ironically, the expected inflation rate is an important determinant of wage increases and the actual course of future inflation.  

When price inflation is expected to be high, or even to accelerate, employers may feel that they can be more generous from their side of the wage bargain.

And of course, employees also want to be compensated for increases in the cost of living.

Indeed, it used to be quite normal that wage inflation would exceed price inflation by at least one or more percentage points. The theoretical basis for this is that the employees should also be entitled to share in the economy’s productivity growth dividend.  

Here are some of the short-term influences that currently seem to be holding down consumer price increases in the US. The sharp decline in global oil prices of course plays a big role at this time. As well, the unusually strong US dollar lowers import prices, and of course, this impact also shows up in the CPI.

Also playing a role is the fact that US corporate profits have been improving and the recent corporate tax cuts accelerated profit growth.

As the following chart from the National Bank indicates, strong corporate profits have recently been associated with relatively low consumer prices. In the third quarter, US corporate profits rose to a record $2.3 trillion, or +10.3%y/y, more than double the 4.2% increase for wages and salaries.

To this economist, however, what is really going on is a substantial shift in market power away from workers towards corporations. The market power shift has been going on for some time, and low inflation may also be a symptom of this.

Of course, what accounts for this shift in the power balance is debatable, but globalization, the new technologies, the relative de-skilling of many in the work force, and the emasculation of unions in the US must be part of the explanation.