Wage growth
The number that decides whether inflation is a passing shock or a self-sustaining process. Also one of the hardest numbers to measure honestly.
Prices rising is a price shock. Prices rising while pay rises to match is a process, because the higher pay becomes the higher costs that justify the next round of price rises. Which of the two is happening is the central question in any inflation episode.
Nominal and real
Nominal wage growth is the change in pay. Real wage growth subtracts inflation, and it is the only one that tells you whether people can buy more. Pay up 4% with prices up 5% is a 1% pay cut, correctly perceived as such by everyone experiencing it. See nominal versus real.
The composition trap
A firm employs 100 people: 50 on $40,000 and 50 on $80,000, average $60,000. A recession removes 20 of the lower-paid. Now 30 × $40,000 and 50 × $80,000 across 80 people — average $65,000, up 8.3%. Not one person received an increase. The composition of who is employed changed, and the average followed.
This is not a hypothetical curiosity. It distorted measured wage growth substantially during periods when job losses were concentrated among lower-paid workers, and it reverses when those jobs return — producing measured wage falls during a recovery.
Measures that handle it better
- Employment cost indices hold the mix of jobs fixed, isolating pay changes for comparable work. Slower to publish and more reliable.
- Wage trackers built from matched individual records compare the same person year on year, removing composition entirely.
- Average hourly earnings is timely, widely quoted, and the most exposed to the problem above.
What ties it to inflation
If pay rises 5% and output per hour rises 2%, unit labour costs rise about 3% — which is roughly what firms need to recover in prices to hold margins. Pay rising 5% alongside productivity of 5% is not inflationary at all. This is why central bankers talk about unit labour costs rather than wages, and why 'wages are rising' is an incomplete sentence.
The wage-price spiral
The feared mechanism: prices rise, workers bargain for compensation, higher costs are passed into prices, and expectations adjust so that the next round starts higher. It requires bargaining power on one side and pricing power on the other, and both vary enormously across time and country.
Episodes where inflation rose sharply without a sustained spiral are common, and typically involved supply shocks that faded before expectations moved. Whether a spiral develops is genuinely uncertain in advance, which is why central banks act on the risk rather than waiting for the evidence.