'What's Up with Wage Growth?'

The introduction and conclusion to an FRBSF Economic Letter by Mary C. Daly, Bart Hobijn, and Benjamin Pyle:

What's Up with Wage Growth?: Improvements in labor market indicators such as job growth and the unemployment rate are strong signals that the U.S. economy is returning to health. One puzzling exception has been the sluggish rise in wages. While wage growth typically rises as unemployment falls, this relationship has been muted in the current recovery. In this Economic Letter, we show that changes in the composition of the workforce propped up wages during the recession, despite a significant increase in labor market slack. As the labor market has recovered, this pattern has reversed. We find that cyclical components, such as the entry of low-wage workers to full-time jobs, have combined with secular components, specifically the exit of higher-wage retirees, to hold down recent measures of overall wage growth. ...

So what are the implications of these insights? The main one is that sluggish wage growth may be a poor indicator of labor market slack. In fact, correcting for worker composition changes, wages are consistent with a strong labor market that is drawing low-wage workers into full-time employment.

In this context, wage growth measures that focus on the continuously full-time employed are likely to do a better job of gauging labor market strength, since they are constructed to more clearly capture the wage dynamics associated with improving labor market conditions. The Federal Reserve Bank of Atlanta’s Wage Growth Tracker is an example.

How to best gauge the impact of wage growth on overall inflation is less clear. As long as employers can keep their wage bills low by replacing or expanding staff with lower-paid workers, labor cost pressures for higher price inflation could remain muted for some time. If, however, these lower-wage workers are less productive, continued increases in unit labor costs could be hiding behind low readings on measures of aggregate wage growth.