Even in a Hot Economy, Wages Aren’t Keeping Up With Inflation

Tight labor markets aren’t as good for workers as D.C. economists imagine. High demand raises prices, too

By Jason Furman. Excerpts:

"The hot-economy thesis has been a staple of Beltway economists from both the left and the right and has been frequently cited by Federal Reserve officials. The idea is simple: When the unemployment rate falls, workers have more leverage to negotiate higher wages. Job growth benefits not only the newly employed, but also those already working."

"This evidence, however, has some weaknesses. The wage increases in the late 1990s likely had more to do with the pickup in productivity growth than strong demand"

"Academic evidence that tighter labor markets boost nominal wages is fairly clear. The same stronger demand, however, also leads to higher prices. It is an open question whether wages or prices rise more."

"Inflation started to rise in 1965 but nominal wage growth didn’t appreciably pick up until 1967, leading to a large decline in inflation-adjusted wages. This may also describe what has happened in the U.S. economy in the past year, especially for middle- and upper-income, workers whose wages are stickier because they are generally adjusted only annually."

"In a boom, the economy draws in more workers and gets them to work more hours. The result is that workers produce less with each additional hour because of the limited capital stock, the influx of less-skilled workers and overall crowding of the production process. In a competitive market, real wages fall when workers produce less per hour."

"A lower unemployment rate strengthens the bargaining power of workers, enabling them to obtain larger nominal wage gains. That same stronger demand, however, also increases the pricing power of businesses. With so many eager customers, businesses can charge higher prices. Which goes up more—the bargaining power of workers or the pricing power of businesses—is theoretically ambiguous. The latest evidence, from economists Christopher Nekarda and Valerie Ramey, favors the idea that businesses’ ability to mark up prices over costs, including wages, goes up in a stronger economy—but this question too is far from settled."

"Millions of new jobs don’t necessarily lead to higher pay for the 150 million workers who are already employed. An observer may decide that the value of those additional jobs more than offsets the cost of inflation-adjusted wage losses, but it isn’t surprising that workers who are falling behind don’t feel the same way."

"moving from a hot economy to an overheated one, as we have done, can also threaten the sustainability of job growth itself."