Figure 10-4: How inflation affects growth in real average hourly earnings
The top panel of this chart depicts Y/Y growth in individuals’ hourly wages in current-dollar terms (black line), compared with Y/Y consumer price inflation—i.e., the PCE deflator (red line). Hourly wage growth less the effects of inflation yields Y/Y growth in individuals’ real (deflated) average hourly earnings (bottom panel, green line)—a good measure of changes in the unit purchasing power of the 90% employed—excluding the lagging effect of employment itself. This is perhaps the most powerful of all drivers of consumer spending and, therefore, the economy in general. Despite this, it is often ignored by economists in their forecasting efforts.
Current Comment: From late 2008 through 2009, Y/Y deflation in consumer prices (red line, top panel) resulting from the economic downturn and financial crisis led to a sharp uptrend in Y/Y real average hourly wage growth (green line, bottom panel). Consequently, unit purchasing power of the 90%+ employed, the largest driving force in consumer spending, was favorable over much of 2009, a significant offset to the negative effects of higher unemployment (a notable lagging indicator). This has been a key factor in the uptrend of consumer spending, which caught so many economists by surprise.
However, the return to moderate price inflation and a consequent slowing of the past year’s exceptional real-wage gains needs to be watched however; any significant further slowdown in real-wage comparisons could threaten the length and degree of recovery in consumer demand.
