The recent inflation surge caught many businesses and policy makers flat-footed. US consumer prices rose 8.6 percent over the 12 months ending May 2022, a jump of several percentage points relative to previous years. Nominal wage growth failed to keep pace. After adjusting for CPI inflation, real average hourly earnings in the US private sector fell 3 percent over the 12-month period ending May 2022.
Some economists have argued that this development intensifies inflation pressures as workers, having experienced a material drop in purchasing power, will bargain for a bigger boost in wages to make them whole. Employers will then accommodate the desire for wage catchup, especially when faced with tight labor markets. The resultant faster wage growth will raise production costs and feed into higher price inflation. For policy makers, a bigger wage-catchup effect implies the need for tighter monetary policy to bring the inflation rate down to a desired level, raising the likelihood of recession.
However, this argument misses a key point: the pandemic-induced shift to remote work is a positive shock to the amenity value of work, meaning that US workers are likely willing to trade off some wage gains to work from home. How strong is this wage-growth restraint on inflation?
To answer this question, the authors develop novel survey evidence to test the mechanism, quantify its force, and draw out its implication. They find the following:
In concluding, the authors remark that their evidence and analysis do not argue for complacency about the inflation outlook; rather, they imply only that the challenge is modestly less daunting than it might seem.