opinion | How do employee wages relate to inflation?

At some level, the wages and salaries that employers pay their employees are just another price — in this case, the price you pay for using someone’s time and effort. If I were a Marxist (which, by the way, I am definitely not), I would say that in a capitalist system, employment becomes a commodity, a purely monetary transaction rather than a human relationship.

But employment is actually a human relationship, and this makes a difference even in a market economy.

You can see this difference in the numbers, by comparing the behavior of wages over time with that of goods that everyone agrees are goods. Here’s the movement since 2002 of two prices, oil and US labor, as measured by the Employment Cost Index (more on that soon):

Oil prices have alternated between falling and rising, depending on global supply and demand conditions. The wages do not; they have grown continuously, although the growth rate varied a bit. Why the difference?

Keep in mind that there were two periods of mass unemployment during that period, after the 2008 financial crisis and during the Covid pandemic. Especially after 2008, unemployment benefits were quite limited and many Americans were desperate for work. Why didn’t employers capitalize on this desperation by demanding that workers accept large pay cuts? After all, there were plenty of other workers willing to take their jobs if they refused.

Well, in 1999 Yale economist Truman Bewley published a book on the subject, “Why Wages Don’t Fall During a Recession.” Unusually for an economist, he tried to answer the question by actually talking to people — especially employers, who could have seemingly demanded refunds from their workers during the 1990-91 recession and the long “jobless” recovery that followed. Why didn’t they take the opportunity?

The answer, he found, came down to the fact that workers are not barrels of oil or shells of soybeans. They are people who, among other things, get angry when they feel abused. Nobody cares about the feelings of a barrel of oil; employers feared that wage cuts, even during an economic downturn, would hurt the morale of their employees and that the resulting damage would outweigh any cost savings.

Economists have long known that wages are sticky — that is, not very responsive to economic conditions. Bewley’s work helped explain why.

And the fact that wages differ from other prices explains why serious discussion about the inflation outlook depends very much on what happens to wages. Falling gas prices are quickly relieving Americans, and there is early evidence that Fed rate hikes are leading to falling prices or at the very least a sharp slowdown in inflation across much of the economy. But this disinflation will not be sustainable unless wage increases fall.

It is true that wages are not the only or even the main driver of recent inflation. But if wages grow at 6 percent annually, as they seemed in late 2021 and early 2022, we won’t be able to push inflation back to the Fed’s 2 percent target. Wage growth doesn’t have to fall to 2 percent — because producers can partly offset rising wages with higher productivity — but stabilizing inflation will mean wage growth will slow significantly. Goldman Sachs says 3.5 percent would do it. Frankly, I think that’s a bit optimistic.

So what’s up? Annoyingly – but all too often these days – different statistics tell different stories. You would think we can only look at average wages. But that data was very skewed during the worst slowdown of the pandemic, which rose sharply as lower-paid workers were laid off in large numbers and then declined as they returned to work. It’s not clear that anything similar is happening now, and the average wage is on a steady decline:

However, there are other measures. The Bureau of Labor Statistics produces the Employment Cost Index, which is believed to correct for the kind of compositional effects that distorted average wage figures in 2020. The Fed prefers a version of the EBI that excludes incentive payments (basically bonuses), also shown in the chart. And while it’s a little lower in the latest release, there’s less evidence of an ongoing decline and it’s still above 5 percent.

All this leaves things… unclear. But inflation seems harder to tame than I’d hoped.

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