U.S. Wage Growth Is Slowing, Somewhat

By some measures, nominal pay raises are now in line with 2006-2007 or the late 1990s. What that means for inflation and interest rates is less clear.

The biggest source of underlying inflationary pressure in the U.S. economy—unusually rapid wage growth—has been receding rapidly in recent months, although not by enough (yet) for policymakers to be confident that they are on track to reaching their 2% yearly inflation goal. The question is whether this process will continue, and if not, what that would mean for interest rates.

Workers’ pay gains have macroeconomic significance because wages are the most important source of financing for consumer spending. When wage growth is too slow, it is hard for businesses to make money sustainably.¹ That tends to discourage investment and hiring, further depressing wage growth and keeping the economy stuck in a rut. Faster wage growth usually means more spending.² That is good to the extent that businesses can ramp up their output of goods and services to meet demand, but it does have the potential to generate shortages or unwanted price increases (or both).

From the start of this century until the pandemic, the problem was that wage growth was too slow. More recently, it looked as if there had been a persistent upward shift in the trend rate of wage growth. While that would have many benefits, it would not have been consistent with the Federal Reserve’s stated 2% yearly inflation target, nor would it have been consistent with the set of interest rates that prevailed in the 2010s.

American workers’ wages are still rising faster than in the decade before the pandemic, but the pace of increases has slowed sharply and is now comparable to the late 1990s and 2006-2007.