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11 Aug 2022 10:59
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  •   Home > News > Business > Features

    Wage Cuts Create Problems

    Increasingly, I am running into people who are taking pay cuts in one form or another in the interest of their struggling employers. I am also aware of a number of companies that have trimmed staff incomes, often by 5% - 10%.

    Investment Research Group
    Investment Research Group
    This is not just happening in NZ but appears to be a global phenomenon. In the UK, wages have been declining for some time, reflecting a cutback in bonuses in many industries. Average weekly earnings have fallen by up to 5.8% in some months this year.

    In the USA, wages have fallen by 4.7% in the 12 months to June, the biggest drop since records began in 1960, according to Commerce Department figures.

    As I have mentioned before, deflation is a good thing when it applies to prices (despite hysterical headlines that suggest otherwise) but it is a very bad thing when it affects the circulation of money in an economy.

    If people have less money to spend, either through retiring debt or lower incomes, then the economy shrinks. Usually, companies react to this by lowering prices and reducing non-essential costs and staff until the recession blows over.

    For the past several decades, the average recession in this country has lasted 18 months. Occasionally, however, a deflationary spiral occurs. If the usual measures aren't enough, companies are forced to ask employees to take pay cuts, which most do in order to protect their jobs.

    This makes the economy shrink even further, forcing further price and wage cuts. Such a spiral is very hard to fix because the usual central bank practice of printing extra money and cutting interest rates doesn't work.

    If people have more money, they save it or retire debt faster, which does nothing to stimulate the demand for goods and services.

    US commentator Steve Saville notes that most views about whether the future will be deflationary or inflationary focus on what will happen to the huge quantity of reserves that the Federal Reserve and other central banks has supplied to the banking industry over the past year.

    The inflationists believe this will lead to a massive increase in the money supply as banks increase their lending. The deflationists, however, are of the opinion that bank balance sheets are so stressed that they can't afford to lend big-time.

    There is also a third group, that he calls the 'just-rightists', who believe that the Fed and others have done a wonderful job of staving off deflation, and will one day remove the excess bank reserves before an inflation problem arises.

    "Our view, which will undoubtedly be considered sacrilegious in some quarters, is that the level of reserves within the banking system is not central to the inflation/deflation issue," he says.

    Saville agrees with deflationists that the banking industry won't contribute significantly to growth in the economy-wide supplies of money and credit over the years ahead, almost regardless of what happens to bank reserves.

    However, he believes they have overlooked the role of the government in doing the same thing. "While there is certainly a risk that the banking system's massive infusion of reserves will eventually contribute to the overall inflation problem, our inflation forecast in no way depends on such an eventuality," he concludes.

    In other words, the outlook is still for inflation, but perhaps not a lot of it for some time.

    © 2022 David McEwen, NZCity

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