The Post-Pandemic Labor Market and Rising Inflation

The Post-Pandemic Labor Market and Rising Inflation

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INSIGHTi

The Post-Pandemic Labor Market and Rising
Inflation
Updated November 22, 2021
As measured by the Consumer Price Index (CPI), published by the Bureau of Labor Statistics (BLS),
inflation has increased relatively quickly throughout 2021. In October 2021, CPI inflation was 6.2%
(measured by the percent change from October 2020), significantly higher than the sub 2% inflation that
had become commonplace since the 2008 financial crisis. There are several reasons this could be
occurring, and some have pointed to the labor market as an explanation. This Insight discusses the
theoretical connection between the state of the labor market and inflation, recent trends in the labor
market, and the dynamics between current labor market conditions and rising inflation in the economy.
Inflation and the Labor Market
Inflation is typically attributed to any number of causes, one of which is increasing production costs. Put
simply, if it costs businesses more to produce goods and services, they will, under most market
conditions, charge more for the final products. There are several inputs in the production process,
including land, labor, and capital, among others. If the price of labor—often measured in wages—
increases, then producers are not able to produce their goods or services at the same price and quantity as
profitably. Given this, and depending on market characteristics, producers may increase prices of final
goods and services, often referred to as cost-push inflation.
In addition, increased wages leave workers with higher disposable income, which, all else equal, can lead
to a rise in aggregate demand. Depending on the increase in demand relative to the productive capacity of
the economy, a rise in prices may result, known as a wage-price spiral. The magnitude of the effect of
increasing wages depends on several factors, including the uniformity of the increase in wages across all
sectors and the state of the economy at the time of the increase in wages.
Labor Market Trends
As shown in Figure 1, the level of employment was relatively high and the unemployment rate relatively
low prior to the COVID-19 pandemic. Following the start of the pandemic, the unemployment rate
increased rapidly to levels not seen since the Great Depression. Employment levels dropped over 20
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million in April 2020 alone. While the employment situation has improved since April 2020, the
unemployment rate as of October 2021 remains over a percentage point higher than in February 2020,
before the pandemic began, and the number of employed persons remains a little less than 5 million lower
over the same period. All else equal, this would imply a “looser” labor market—that is, one featuring a
high amount of available labor relative to job openings and less upward wage pressure—in 2021 than in
2019.
Figure 1. Employment and Unemployment Situation
January 2019 to October 2021

Source: Bureau of Labor Statistics (BLS), Current Population Survey.
Despite the relatively “loose” conditions in the labor market overall, certain industries have shown
characteristics of a “tighter” labor market, such as difficulty in hiring, increased bargaining power, and
nominal wage growth. To illustrate with an example, Figure 2 shows the average hourly earnings (i.e.,
wages) of all employees in the private sector and employees in the leisure and hospitality sector, an
industry that took relatively severe employment losses and has yet to recover in terms of employment
levels.
Average hourly earnings increased substantially in April 2020 as lower-wage workers lost their jobs at a
higher rate than higher-wage workers at the onset of the pandemic, thereby increasing the average wage.
Wages began to normalize somewhat in May, when overall hourly earnings dropped quickly, but
remained elevated compared to what they would have been had they continued on their pre-pandemic
trajectory. Earnings growth largely returned to its previous long-term rate beginning in June 2020,
although growth has been especially strong in recent months. It is, as of yet, too early to know if this
recent increased rate will be sustained.
In contrast, leisure and hospitality earnings losses following the early spike were more severe, and the
early recovery less robust, as demand for in-person services was significantly dampened by restrictions
and concerns over the spread of the virus. However, wages in this sector have increased at a more rapid
rate in 2021 than the private average. In this case, the increase in wages is, in large part, an effort to attract
workers, some of whom switched jobs during the pandemic or are taking advantage of current labor
market conditions to switch industries.

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Figure 2. Nominal Average Hourly Earnings
January 2019 to October 2021

Source: BLS, Current Employment Survey.
Wage Growth and Inflation in 2021
The data above may suggest demand for labor amidst the recovery from the pandemic could be putting
some upward pressure on wages. This, in turn, could put upward pressure on prices. While inflation refers
to the general increase in prices across the economy, and wages and prices are not increasing across all
sectors and industries, increased prices in specific industries can significantly affect inflation in the short
run. For example, BLS attributed more than a third of the increase in overall prices in the month of June
to a 10.5% increase in the price of used cars and trucks over the same period. As of October, price
increases were broader, with energy, shelter, food, used cars and trucks, and new vehicles contributing
significantly to inflation.
It is possible that inflation will slow as supply becomes less constrained by pandemic disruptions, as
many (including Federal Reserve Chair Powell) believe. Wage growth may also slow should supply
become less constrained. That said, the relationship between wages and inflation is not unidirectional.
Increased wages have the ability to put upward pressure on prices, but increased prices also have the
ability to signal to workers that they should demand higher wages to compensate themselves for inflation.
Should expectations of high inflation become ingrained in the public, it is likely that workers would do
so, thereby putting further upward pressure on prices. Overall wage gains have not outstripped inflation
yet and are thus unlikely to contribute to sustained increases in inflation at this point.

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Author Information

Lida R. Weinstock

Analyst in Macroeconomic Policy

Disclaimer
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