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Can Wage Growth Keep Up With Inflation?

Jacob Hess
May 06, 2021

Inflation is the buzz word of the time and one of the top concerns of investors and economists following the recovery from the COVID-19 pandemic. The most recent CPI and PPI releases for March have already hinted at elevated price levels being inflated by surging consumer optimism, falling infection rates in advanced economies, and successful vaccination pushes. Fed members have already confirmed that they are comfortable with inflation running past its former inflation target of 2.0%; Governor Michelle Bowman recently said so herself that "headline inflation measures will move above our [the Fed's] long-run target of 2.0%." That being said, it now should be fully expected that inflation is going to be a near-term reality.

Inflation in its most pure definition makes goods and services more expensive for consumers, a consequence that the Fed and managers of the economy may have to deal with for the next year (supply shortages in many markets could exacerbate these consequences). This could result in weaker consumption numbers if price levels get out of hand which would be a significant drag on consumption-reliant GDP growth. This is especially true if wages don't grow at a comparable level to prices.

From FRED, Continued Claims / All Employees, Total Nonfarm.

The wage issue has really taken a backseat since the pandemic began as restrictions forced mass furloughs and even permanent layoffs that lead to the need for increased unemployment benefits and direct stimulus payments from the government. The focus was correctly drawn away from wages to relief because it incentivized a proper public health response to the pandemic and because continued claims would rise to its highest level ever with respect to total unemployed (see chart above), and this does not include support from pandemic assistance programs which would put the peak claims-to-total employed ratio near 20%. But that focus should start to shift back towards wages as full employment is the target and government relief becomes less important once again. What has wage growth looked like since the pandemic began?

From FRED, YoY Growth, (blue) Average Hourly Earnings, (red) Employment Cost Index, (green) Gross Domestic Income, Compensation of Employees / All Employees, Total Nonfarm.

The few wage indicators for the US are the average hourly earnings (AHE) from the BLS, the employment cost index (ECI) from the BLS, and total compensation of employees from the BEA over the total amount of employees (also from the BLS). Two of these have grown significantly since the beginning of the pandemic, AHE and total-compensation-to-total-employees, while ECI has kept with its trend. It is worth noting that the BLS's ECI is calculating using a base long-term employment figure that may not encapsulate the increases in "temporarily absent workers." This may mean the true current ECI for the last three quarters should be higher.

True wage growth over the pandemic is probably closer to average hourly earnings which shot up to an 8.2% YoY gain in April and, since June 2020, have an average YoY gain of about 4.8%. This is similar to the total-compensation-to-total-employees indicator which peaked at an 8.2% YoY gain in Q2 2020 but instead of dipping, remained near an 8.0% YoY gain from Q3 2020 to Q1 2021. This is probably a result of health benefits being counted in compensation which were heavily used to cover the costs of COVID-19 to employees, so it's likely that paid wages as a component of gross domestic income trended more closely with AHE.

One thing is clear. Wage growth, which is known for being stubborn, broke trend in 2020 and for a good reason. Employees in many industries like hospitality, leisure, and retail were putting themselves at a higher risk of infection by staying employed therefore needing a sort of risk premium added to their wages. This came in the way of "hazard pay." The high wage trend was also a result of low wage earners being more likely to lose their jobs than high wage earners, a topic on which the White House recently published a note. Both these trends are likely "transitory," and their effects are exclusive characteristics of the pandemic economy.

From FRED, Job Openings.

Transitory. It's that word again. Can we count on wage growth to keep up with this new trend? Or is it destined to flatten out again? In a vacuum, growth would probably flatten, but there are many factors that could keep YoY wage gains higher in the near term. First, demand for labor in the US has already started to increase. Job openings in February 2021 were already 5.1% above February 2020 (which is considered pre-pandemic levels), and they are set to increase more when activity heightens in the summer. Finding labor at pre-pandemic prices is also likely to be more difficult with the enhanced unemployment assistance program not set to expire until August. On top of all this, minimum wage workers, the workers that have seen more layoffs during the pandemic, are hearing about a federal minimum wage hike to $15/hour which, if anything, has raised expectations of the type of wage they think they should have.

In the end, no matter how wage growth trends, it is likely to be overcome by inflation. In the scenario that low-wage earners come quickly back into the market at the low wages that they the market with, near-term inflation rising towards 3% will be felt. In another scenario where overall wages increase and keep with the pandemic growth trend, price levels rise even further as firms pass on the elevated costs of raw materials AND labor to the consumer. Suddenly, the excess savings from 2020 buys less goods and services in 2021. It will take successful management of this transition period from an economy that has been put on hold for almost a year to an economy that is seeing a rapid increase in demand to maintain a proper level of inflation so that developments in wage growth aren't harmful to either consumer OR firms.