Who Won the Race Between Wages and Inflation?

In 2021, a lot of attention was paid to inflation — the economic term for rising prices. (Leave it to economists to take a term with 12 letters — “rising prices” — and turn into jargon that’s just two letters shorter!). When someone says that the inflation rate is 2%, then something that costs a $1.00 today would cost $1.02 in a year.

The focus on inflation stems from the fact that it was high in 2021 relative to recent history. Consider that from 2000-2020, the inflation rate for all goods averaged 2.1% per year. For 2021, the number was 4.5%. In the last six months of 2021, it was even higher, at 5.7%. So, inflation is certainly on the upswing.

So, how concerned should you be? If you listened to certain commentators, you would certainly think that the sky is falling. And, the truth is that inflation can be a major problem. But, has it been so far? To evaluate, let’s first think about how exactly price increases can hurt Americans. Then, let’s look at the past year and consider any damage done.

Inflation: When is it Bad?

Inflation certainly has a bad rap. All of us were taught about the Weimer Republic, and how people in Germany post-WWI ended up burning money because fuel prices had increased so much that the money was cheaper. Indeed, some people seem to bring this up anytime the government tries to do anything. For example, the fear of hyperinflation due to Quantitative Easing following the Great Recession was definitely a thing. Ah, yes, I remember burning my money for fuel in 2011. Oh wait…I used money to buy fuel when inflation remained mild. But, I digress…

Still, inflation definitely can be a problem. For example, consider that the vast majority of Americans get their income primarily from wages and salary. If prices grow faster than workers’ wages, then their purchasing power declines. If you make $1,000 a week and the price of gas goes from $3 to $4, you go from being able to buy 333 gallons a week to just 250 gallons. So, workers can definitely be hurt from inflation.

Savers can also be hurt. Aside from their homes, the only wealth most Americans hold is in retirement accounts like 401(k)s. Should inflation outstrip the returns on those assets, then retirement savings can actually become less valuable over time. So, rampant price increases are a risk here as well.

So, in 2021, how bad was inflation for workers and retirement savers?

Inflation, Wages, and Saving in 2021

To look at whether or not wages kept pace with inflation in 2021, I went to the Current Population Survey. This dataset — used to calculate statistics like the national unemployment rate — contains data on weekly earnings. This information was then combined with data from the Federal Reserve on price increases to see if wages were outpaced by inflation.

The answer is — as usual for an economist — “it depends.” It turns out, 2021 was a pretty good year for lower earners, but less good for middle- and higher-earners. Figure 1 shows how price increases (red line) compared to wage increases for workers at various wage percentiles since January 2021. The figure shows that the lowest 25 percent of earners saw their wages grow substantially faster than inflation. However, workers at and above the median saw their purchasing power decline.

Figure 1. Price and Wage Increases January 2021 – November 2021 (100 = January 2021)

Source: Author’s calculation from University of Minnesota CPS-IPUMS and Federal Reserve Economic Data.

If you are a frequent reader here, you will know how strange it is for lower-income workers’ wages to outpace higher-income ones. But, that’s what happened in 2021. So, despite inflation, lower-wage workers have seen their purchasing power increase. Middle- and upper-wage workers have seen it decrease. What about saving?

Here, the answer is…you guessed it…it depends where the money was saved. Money saved in lower interest rate assets like savings accounts or government bonds have likely been substantially eroded. However, the most important source of savings for many Americans is retirement savings. And, the majority of retirement savings is held in equities. Well, the S&P 500 grew by 27 percent in 2021. Meaning, even accounting for inflation, people’s retirement savings likely grew by more than 20 percent.

So, inflation in 2021 was hardly a crisis for workers or savers.

What I’m Looking for in 2022

As 2022 dawns, I’m very curious to see what happens to both inflation and wages. I’m not a macroeconomic forecaster. But, on the inflation front, I expect some abatement in the coming year. A very simple way to think about inflation is that it happens when people have money to spend but there aren’t that many goods available. Well, the Trump/Biden stimulus fueled bounce to checking accounts is winding down. And, supply chain issues are likely getting better (although it will be interesting to see how Omicron affects this progress). So, I will put myself down as expecting lower inflation in 2022 than 2021 (but likely higher than usual).

On the wage front, a lot depends on whether low-wage workers are able to hold onto their new found power and whether higher-income workers ultimately benefit from the tight labor market. I’m cautiously optimistic. After all, job openings — a measure of the competitiveness of the labor market — are at an all time high. Figure 2 shows the “job opening rate,” the number of openings in the economy relative to the number of employees. The increase in openings has been extreme. When demand is this high, it’s hard to imagine wages at least not keeping up with inflation.

Figure 2. Job Openings Rate, 2000-2020

Note: The job opening rate is the number of openings in the U.S. divided by the number of employees plus openings. Source: U.S. Bureau of Labor Statistics (2021).

Indeed, one concern many people have is that inflation remains high and workers maintain their power. The end result of this could be an “inflation spiral.” Such a spiral can happen when prices rise, so workers demand higher wages, so employers have to further raise prices to afford their workers, and so on. While, I doubt this fear will play out, it is another thing I’ll be watching in 2022.

To end this post, I just want to mention one more thing that I’ll be watching — bad faith inflation fear mongering as a way to forestall useful government policy like universal child care. After all, we’ve had 40 years of low inflation. And over that time period, middle-income workers wages have barely kept up with it. Lower-income workers wages haven’t even done that — for many, their purchasing power has actually shrank despite low inflation. What I would like to see in 2022 is less fear about six months of high inflation, and a little more worry about 40 years of policy that have yielded workers nothing.

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