Why aren’t prices falling?

Martin Wolf in today’s FinancialTimes asks “Why are the high income countries not mired in deflation?”. And one sentence later he says, “It is weird that inflation has remained so stable, despite huge falls in output..”.

His answer is that everyone now has faith in central bank inflation targeting. That is, central banks aim for 2% inflation, so inflation is actually around 2%.

But that rather begs the question as to how, given that supply exceeds demand, employees manage stop wages falling in nominal terms and how employers manage to stop the prices of their products doing likewise.

As regards wages, pay awards seem to have averaged about 2.5% in 2010, 2011, and 2012 in the UK (Sources are below). And that is despite productivity actually FALLING (see chart on p.iii here, and table 57 on p.59).

So it looks like Keynes’s dictum about wages being “sticky downwards” was an understatement. That is, employees like getting their annual 2% or so pay increase REGARDLESS of productivity increases or lack of. 

Employers’ pricing strategies.

As to lack of firms willing to drop their prices because of lack of demand, I don’t see any “sure fire” answer there. However, it seems that firms determine their prices to a significant extent simply by the “mark up on costs” method. That way of determining prices seems to be about as important as reacting to what the competition is doing with its prices (see here and here). So presumably the “mark up on costs” phenomenon is just influential enough to ensure that prices keep up with wage increases.

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Sources for wage increases.

1^st quarter 2010. 1.9%

Sept, Oct & Nov 2010: 2.2%

1^st quarter 2011. 2.5%

3 months to sept 2012: 2.5%

4^th quarter 2011. 2.5%

Whole of 2012. 2.5%  

First quarter 2013.  3.5%.