Real vs. Nominal Wage Growth

Vince Brennan: Welcome to the Federal Reserve Bank of St. Louis’ Timely Topics podcast series where we interview St. Louis Fed economists about their research. My name is Vince Brennan, and today I’ll be joined with St. Louis Fed economist Victoria Gregory, who will discuss her research in real and nominal wage growth. Thanks for joining me today, Victoria.

Victoria Gregory: Thanks a lot for having me on.

Brennan: Well, we’ll start with: Since the pandemic, wages have been on the rise for workers across the country. But there are a few different ways to measure wage growth, one of them being real wage growth and the other nominal wage growth. Can you explain these measures and the difference between them?

Gregory: Yeah. And how wages have evolved over the past few years has been a key point of interest for both policymakers and the individuals themselves. So, of particular concern is the extent to which your wages have kept up with the rising cost of living. And that’s kind of where the distinction between real and nominal wage growth comes in. So, the basic difference is that nominal wage growth is just the raw change in wages for someone like, at an annual level, etc. Real wage growth takes into account the inflation rate.

So, just as an example, at the annual level, so someone’s nominal wage growth is just going to be the difference in perhaps their hourly wage from one year to the next, just by looking at your paychecks or your W-2 forms or something. So that’s, like, exactly what something like the Atlanta Fed’s wage growth tracker looks like. So just year-on-year changes in wages for the same individual from one year to the next. And these numbers have been pretty high over the past few years as the U.S. recovered from the pandemic. So, they’ve been hovering at around 6%, which is a lot higher than, kind of, the pre-pandemic normal, which was around 3% to 4%. But as we all know, inflation has also been very high and so, when you take into account the inflation rate, this is going to give you your measure of real wage growth, and if this number is positive, then it’s going to mean that your wages have kept up with the cost of living. If it’s negative, it means that they have not.

Brennan: So, walk us through your research into this topic and why economists look at those specific measures.

Gregory: Yeah. So, economists are interested in this distinction because real wage growth tells you something about whether a household is kind of better off from one year to the next. So, are they still able to purchase the same basket of goods with the same ease as they did this year compared to last year? And it’s been very interesting this year because, as I said, kind of, nominal wage growth has been hovering around 6%. Inflation, for the same time, has been hovering around 8%.

So, this back-of-the-envelope calculation tells you that for the median household, their wages fell by 2%. People differ in terms of their labor market experiences, the kinds of goods they consume. So, the negative 2% number is not going to be the same for everyone. So, in my research, I wanted to understand how different households differ in terms of whether or not their paychecks have kept up with inflation. So, I wanted to examine the heterogeneity around that negative 2% number.

Brennan: Before we continue, I’d like to invite listeners to subscribe to the St. Louis Fed’s Central Banker e-newsletter. Twice a month, this newsletter will be delivered right to your inbox for the latest interviews, articles and podcast episodes about research at the St. Louis Fed. Subscribe at stlouisfed.org.

Now back to our discussion. Many households are paying close attention to inflation and the rise in the cost of goods and services. But what goes into a household’s measure of real wage growth, and how does it relate to the consumption of goods?

Gregory: So fundamentally it’s the same information that goes into the aggregate measure that I was talking about before. Except for, each of the components is measured at the individual or household level. So, the nominal wage growth part is the more straightforward part. So, I use data from the CPS (Current Population Survey), which is a monthly survey of a representative sample of the U.S. population. And it’s the same data that’s used to create the monthly jobs reports. So, in that survey, they ask about wages for people taken one year apart. And I can just look at the percent change in those wages to figure out somebody’s nominal wage growth.

The inflation side is a bit more complicated because that’s where this depends on the types of goods and services that an individual consumes. And so, these categories are things like food, transportation, health care, housing, utilities—those are, kind of, the biggest categories. As people might know, the aggregate inflation rate is calculated based off of an average consumer basket. But of course, people are going to differ in terms of what that basket looks like for themselves.

So, the challenge here was to create individualized consumption baskets and kind of impute these into the CPS where I had this nominal wage growth data. So, I used the Consumer Expenditure Survey to do this, which is the same data set that’s used to create the aggregate inflation rate. And so, I just looked at differences in consumer baskets for households of different income levels, sizes, education levels. And then, based on these patterns, I imputed a consumption basket to everybody in the CPS where I had the nominal wage growth. And by also using the CPIs (consumer price index) for these different goods categories, I was able to come up with an individualized inflation rate for each person in the CPS. And I compared that with their nominal wage growth to get an individualized measure of real wage growth.

Brennan: Well, let’s drill down on that a little deeper. How have some price increases and wage changes been affecting households? I imagine some are faring better than others.

Gregory: Yeah, exactly. I found, actually, a lot of heterogeneity in terms of these real wage growth rates. So, first of all, kind of on average I found that for around 57% of individuals, their wages had not been keeping up with inflation, which was to say that they had negative real wage growth. But there’s a lot of differences here. So, some individuals had as high as like 20%, 40% real wage growth. Some people had, you know, drops to that magnitude. And what seemed interesting is that the main thing in determining kind of where you fell in the real wage growth distribution, it seemed to be more about what was happening with your nominal wage growth. So, if somebody had really high wage growth, it was because their wages in the labor market grew and not really because they had, like, a lower level of inflation than the average person.

So, in terms of observable characteristics, so I found that lower-earner households tended to do a lot better than higher earners because they had higher nominal wage growth rates. I also found some interesting heterogeneity in terms of age. So older workers did a lot worse than younger workers. And in fact, workers under the age of 25 was the only group where I found had, actually, positive real wage growth over the last year.

And then, there was another interesting dimension along, like, the job switcher versus job stayer. So, it seemed like people who had switched jobs over the last year had done better than people who had stayed in their same jobs. And that kind of squares with the really high quits rates that we’ve seen over the same time frame. And it seemed like the people who had actually gone on and quit their jobs were also getting—many were getting wage increases and thus, had done a lot better in terms of real wage growth and weathering those changes in inflation.

Brennan: Well, you mention a lot of interesting trends. Is the data saying anything about where these trends are going in 2023 and beyond?

Gregory: Yeah, so there’s no data out yet for the individual level in terms of the consumption baskets. So, I don’t know much about what’s going on there yet, but we can still look at the aggregate numbers for nominal wage growth versus the inflation numbers to see what’s going on for, kind of, the average person. So nominal wage growth has still been holding steady around 6%. Whereas the inflation readings have, kind of, been a little bit more subdued lately. Like those have come in around, like, 5% in the past two months, down from the 8%/9% all-time highs we were seeing.

So together, this kind of seems like workers this year are more or less breaking even in terms of real wage growth. And if the inflation readings continue to subside and nominal wage growth remains high at around 6%, it seems plausible that soon we’d be back to the pre-pandemic level, which was kind of like a 2%/3% increase in real wage growth per year.

Brennan: Yeah, these are important measures that I’m sure we’ll be following for months to come. But before we wrap today, is there one thought that you want listeners to come away with on this podcast episode?

Gregory: Real wage growth is, kind of, just one part of the picture as to understanding whether households have become economically better well-off, compared to, like, last year or 10 years ago or a generation ago. There’s also a lot more things that we should take into account when trying to understand this. So, things like, what kind of wealth are households holding and how have those values changed over time? Also, changes in the quality of goods and services produced. These are all things that are part of the broader picture that people look at to understand, you know, like improvements in economic situations. But I do think that this real wage growth measure has been particularly important over the past few years, given this relatively high inflation period that we’ve been in.

If you go to any household and you ask them, why don’t they like inflation, it’s because they would say that their wages can’t keep up with it. And so, that’s kind of where I started this research from and just, kind of, understanding how this situation has been affecting households differently.

Brennan: Well, Victoria, thank you for joining us on the St. Louis Fed’s Timely Topics podcast series. If you want to learn more about Victoria’s research or others’ at the St. Louis Fed, visit stlouisfed.org. Thank you.