I have said this many times --- the most important reason to study economics is so you won’t be fooled by economists. (I would actually add journalists and politicians to that list.)
Nowhere is this more important than when talking about inflation.
Let’s start with the simple definition: Inflation is a rise in prices in general.
[Sometimes it’s hard to realize but think of it this way – every item has a price --- there are literally thousands of prices of thousands of products and services. To get the inflation rate, economists measure some AVERAGE of the changes of all prices. Thus, in fact, there are a number of different “inflation rates” counted and reported by the Bureau of Labor Statistics. The one usually mentioned in news articles about inflation is the Consumer Price Index which measures the prices of a group of products and services that are bought by consumers. Left out would be things that mostly businesses buy --- like crude oil, farm harvested wheat, iron ore ---those are included in different price indices.]
Many people will argue that any inflation rate harms people because everything costs more. First of all, that’s not true – even if the inflation rate is positive, there might be some prices that are actually falling. However, if the inflation rate is a positive number that means that in general “things” cost more. But that doesn’t tell the whole story. If the prices of everything (most things) goes up, perhaps the price of the product or service that YOU sell will go up.
So this gets us to our first step towards coming to grips with whether inflation is harmful or not. If prices in general go up 3 percent, what if the average price of the products I sell in my business (say hardware from my store) goes up 4 percent? That means I’m ahead of the inflation. If my prices only go up 2 percent, then I am losing out to inflation. If you are a worker, the question becomes --- did my pay go up MORE or LESS than inflation?
In other words, the rate of inflation by itself tells us next to nothing.
Which brings us to the recent experience of the US economy with inflation. Since April of 2021, there has been a lot of talk about inflation. In the previous year, the first year of the pandemic and the pandemic-induced recession, there was almost no talk about inflation. The reason is that the rate of inflation fell dramatically in the early months of the recession. And, despite the fact that unemployment went up dramatically, wages kept growing at about 3 percent a year.
[There is a real good diagram that summarizes just about every fact I am about to present. It is available from an organization called STATISTICA and it is entitled: “Difference between the inflation rate and growth of wages in the United States from January 2020 to May 2023,” available here. This diagram shows the rate of growth of wages and the inflation rate at intervals of about two months for the period before the Pandemic-induced recession till May of this year.]
The reason wages kept growing during the recession is obvious. The government spent a tremendous amount of money supporting the incomes of businesses and individuals which permitted those businesses to pay workers decent wages. Yes, many people lost their jobs but wages on average did not fall.
But as the economy began to recover from the pandemic induced recession, prices began to rise at faster rates than wages. And for over a year, things kept getting worse. Between April of 2021 and June of 2022, the rate of inflation rose from 4.2 percent a year to 9.1 percent a year. And during those months, average wages could not keep pace. In other words, the prices the average worker paid went up MORE than the numbers in their paychecks. The good news was that during this same period, the rate of unemployment fell as many people who lost their jobs during the early months of the pandemic went back to work. It was better to have a job than not --- even if your wages didn’t buy as much as before.
Nevertheless, during this period when the inflation rate was rising journalists and politicians began to talk about inflation. In March of 2022, the Federal Reserve began to increase interest rates --- hoping to cool down the economy and therefore bring the inflation rate back down. When the recession began in 2020, the Fed had cut the interest rate it controls to zero --- and kept it there for two years. The increases that began in March of 2022 pushed that rate to 5.5% by May of 2023. The fear associated with such swift interest rate hikes is that it will trigger a recession (as has happened in the past many times). So far this does not appear to have happened even as the inflation rate began to fall.
[The Fed directly controls a very short-term interest rate called the Federal Funds Rate --- it’s a rate banks charge each other for very short term loans. Changes in that rate have a ripple effect on other rates. For example, between January of 2022 and October of the same year, mortgage interest rates went from about 3 percent to 7 percent as the Fed was raising its rate.]
Whether caused by the Fed’s actions or other factors (supply chain problems were solved, etc.) beginning in June of 2022, the inflation rate began to fall, even though employment kept going up.
[This is actually somewhat unusual. Usually, when the FED raises interest rates, it causes businesses to cut back their spending and unemployment to go up, reducing the upward pressure of wages. Despite the Fed’s actions, unemployment kept falling and wages kept rising. Meanwhile, beginning in the same month (May, 2022) that inflation hit 9.1 percent, wage increases stayed above 6 percent through May of 2023 as the inflation rate kept coming down. This suggests that wage increases had never been the cause of the inflation surge and that therefore, attempting to cure the inflation by increasing unemployment would have been a bad policy.]
From May 2022 through February of 2023, wage increases continued to trail inflation but by decreasing amounts. In February of 2023, wage increases exceeded inflation for the first time in almost two years. And over the last few months, that gap has increased so that in May of 2023, wages were up 6 percent on average while inflation was up only 4 percent.
[The day I recorded this commentary, the June figures were released. Inflation in June was down to 3 percent and even though wage increases were only 4.4 percent, workers were still getting ahead of inflation.]
Why do I spend so much time walking us through these numbers. It’s because it is so easy for someone to get on television and say --- “Inflation is harming our economy and our people.” (as Republicans have said for the last year). And it is NOT a sufficient answer to claim “The rate of inflation is coming down” (as people from the Biden Administration have been saying for months.) BOTH of those statements are woefully incomplete.
Moral of the story: If you hear people complaining ONLY about inflation without any reference to wages, those are the people to be wary of --- they either are ignorant (which is no sin – lots of people are ignorant about lots of things --- ignorance does not equal stupidity) --- OR – (and this is true of most politicians) they are dishonestly manipulating the data to score political points.
So far, I have only talked about wages on average. However, one of the most dramatic changes that has occurred since the start of the pandemic has been the rapid RELATIVE increase in wages at the bottom of the economic ladder. According to detailed research by the National Bureau of Economic Research:
“Labor market tightness following the height of the Covid-19 pandemic led to an unexpected compression in the US wage distribution that reflects, in part, an increase in labor market competition. Rapid relative wage growth at the bottom of the distribution reduced the college wage premium and counteracted approximately one-quarter of the four-decade increase in … wage inequality. Wage compression was accompanied by rapid nominal wage growth and rising job-to-job separations—especially among young non-college (high school or less) workers.”
[This means that people feel more free to leave their jobs in search of better jobs --- this happens whenever the unemployment rate is very low as during the recovery from the pandemic-induced recession.]
At the state-level, post-pandemic labor market tightness became strongly predictive of price increases … real wage growth among low-wage workers … and aggregate wage compression.
[real wage growth is just the numbers on your paycheck minus how much inflation had occurred. This statement means that even as AVERAGE wages were rising at LESS than the rate of inflation, this was NOT true for the lowest paid workers – a point I have stressed in previous commentaries. “Wage compression” just means the ratio of highest paid to lowest paid workers declines.]
Simultaneously, … a key measure of labor market competition—rose among young non-college workers, with wage gains concentrated among workers who changed employers and industries. … [T]he pandemic … reduc[ed] employer market power and spurring rapid relative wage growth among young non-college workers who disproportionately moved from lower-paying to higher-paying and potentially more-productive jobs.”
[In other words, employers were now having to COMPETE for workers rather than many workers competing for few jobs. If employers have to compete, they have to offer higher wages – when workers compete owners can get away with paying close to the minimum wage.]
[The report is entitled “The Unexpected Compression: Competition at Work in the Low Wage Labor Market,” It is written by David Autor, Arindrajit Dube and Annie McGrew and available here.]
Think of that. For FOUR DECADES lower wage workers have been losing out – but in the last three years, they have gained back 25 percent of what they had lost relative to their more affluent fellow workers. That’s very good news indeed === news that the nay-sayers who have been screaming about inflation for over a year will almost certainly ignore.
Michael Meeropol is professor emeritus of Economics at Western New England University. He is the author with Howard and Paul Sherman of the recently published second edition of Principles of Macroeconomics: Activist vs. Austerity Policies
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