The first thing we learned in economics is how prices are determined by the interaction between demand and supply. High demand and low supply causes prices to rise - and vice-versa.
Economists have already coined the term "stagflation" - an economic state of no growth (stagnation) and elevated inflation - but we still have to come up with a nomenclature for the current growth/inflation dynamics around the globe.
Yes, Virginia, the present dynamics where growth momentum is strengthening but inflation remains a no-show and one that was reinforced only last week by the release of the US non-farm payrolls report.
The latest report showed the US economy added 222,000 jobs in June - much more than the expected 170,000 gain - and revisions to the prior two months saw an additional 47,000 increase to the jobs numbers. Although the unemployment rate ticked higher to 4.4% from the 16-year low of 4.3% recorded in May - a function of the increase in the participation rate from 62.7% to 62.8% in June - it's still below the NAIRU (non-accelerating inflation rate of unemployment) as measured by the OECD (4.9%) and Oxford Economics (4.5%). The increase in the average workweek to 34.5 hours in June from 34.4 hours in the previous month indicates further improvement in demand for labour in the coming months.
Perhaps more telling, despite rising to 8.6% in June (from 8.4% in May), the U-6 unemployment rate - which the Bureau of Labor Statistics (BLS) define as: "Total unemployed, plus all persons marginally attached to the labor force, plus total employed part time for economic reasons, as a percent of the civilian labor force plus all persons marginally attached to the labor force" - remains at its lowest level since 2007 (pre-GFC) and represents a very sharp improvement from the peak 17.1% rate recorded in late 2009/early 2010.
If these do not read high demand and less supply, I'm not sure what does. But the law of supply and demand we learned in Economics 101 does not seem to apply these days.
High demand and less supply of labour is not equating to a high price for labour. The same US non-farm payrolls report showed that average hourly earnings grew by only 0.2% in June with the similarly weak 0.2% advance in May lowered to an even slower 0.1% gain. Year-on-year, wages growth improved slightly to 2.5% in June from 2.4% in the previous month but is more than a full percentage point lower given the historical correlation between the unemployment rate and wages (around 3.6% prior to the GFC).
Could it be that like the Fed's doubts over the equilibrium level of the natural fed funds rate, the non-accelerating inflation rate of unemployment (NAIRU) in America is now lower? Perhaps. But this doesn't explain low wages growth observed in most other big world economies.
Whatever the reason/s, low wages are feeding into low inflation that, in turn, is feeding low wages (because most wages are indexed to inflation).
This is not a problem. Low inflation could offset low wages growth in the sense that it could maintain/raise real disposable incomes. The problem is if low inflation expectations become entrenched (Yellen's current concern).
Entrenched low inflation expectations discourage consumer spending - because prices will be the same tomorrow as they are today at worst, or lower tomorrow than today at best - dampening growth and putting greater downward pressure on prices.
All up, RBA governor Philip Lowe is correct in saying that, "there is no longer an expectation of additional monetary easing in other major economies" but don't expect an immediate and abrupt exit as well.