Wages were up in 2021. The Bureau of Labor Statistics (BLS) reports that average hourly earnings of all employees in the private sector increased on a seasonally adjusted basis from $29.91 in December 2020 to $31.31 in December, an increase of 4.7% year-over-year. This seems like great news for workers.
Workers, however, care about what their wages can purchase, and not just about the number of dollars they receive in pay. If the price level stayed constant, an increase in wages is an increase in purchasing power. Unfortunately, the price level did not stay constant in 2021, and it did not grow at the Federal Reserve System’s announced target rate of 2%. No, the price level grew much faster than the Fed predicted. The BLS reports that its Consumer Price Index (CPI) increased 7.1 from December 2020 to December 2021.
Economists talk about the ‘real wage,’ the inflation-adjusted wage. Workers received a 4.7% pay increase, on average, in 2021, but prices went up 7.1%. So, workers actually had a decrease in the purchasing power of their wages. Their ‘real wage’ decreased by 2.3% in 2021 because price increases exceeded wage increases.
The (old) Keynesian approach to conducting expansionary monetary policy was to generate an unexpected inflation, so that while workers might have wage increases, the purchasing power of their wages actually shrunk. In this approach, the lower real wage of workers leads to increased demand for labor by businesses, because businesses care about the cost of labor relative to the price at which goods and services can be sold. The lower real wage thus leads to increased employment and an increase in economic output or GDP. This Keynesian approach didn’t much dwell on the negative impact on workers of the decline in their real wages.
Well, the 2021 labor market looks a lot like that old Keynesian approach. Years ago critics of this Keynesian approach pointed out that workers won’t be fooled for very long by such an unexpected inflation, and that eventually wages will adjust to the price increase to restore worker purchasing power. This suggests that we should expect wages to rise even faster in 2022, relative to prices, as wages recover from this unexpected bout of inflation. The ongoing churn of workers quitting employers to take other jobs, a phenomenon labeled as ‘The Great Resignation,’ is one symptom of a labor market adjusting to this decline in real wages.
There are other costs as well. Federal Reserve System credibility has taken a hit. Workers – and firms – will have a bit less trust going forward in Federal Reserve System promises of low and steady inflation.