The central economic debate in the United States right now is how aggressive the Federal Reserve should be in its efforts to reduce inflation. Few economists argue against the need for higher interest rates to reduce demand, but there are trade-offs, at least in the short term. If monetary policy is too restrictive, we may have an unnecessary recession; if it’s not tight enough, inflation will persist and perhaps take root in people’s expectations, so that it will become more difficult to bring it down later.
Furthermore, there is a question of where to stop: even some economists who have been relatively hawkish, such as Olivier Blanchard, former chief economist of the International Monetary Fund, have argued that bringing inflation down to 3%, rather than the current target of 2 percent would be good enough.
To a large extent, we are talking here about balancing the risks. But how you assess those risks depends in part on how bad inflation really is. And one argument I’ve heard a lot lately is that inflation is bad because it hits low-income households particularly hard.
But is this statement correct? It seems like it should be true. And it’s all too easy to find scenes of unequal hardship in America today, with the 1% or even the upper middle class still living the good life while low-wage workers desperately seek help from food banks.
Inequality, however, is not something that has happened in the past two years; you could have found such scenes at any time over the past few decades, even when inflation was low. And to the extent that low-income families are facing more hardship than a year ago, much of that can be attributed to the expiration of pandemic-era aid, particularly l expansion of the child tax credit.
So what can we say about the effects of inflation, specifically, on low-income families? What the data seems to say is that these families were actually hurt less than families with higher incomes. Certainly, as I will explain in a moment, there is an asterisk on this conclusion, because not everyone faces the same rate of inflation. But there is also an asterisk on this asterisk.
First, let’s note a key fact about the past two years: this era of runaway inflation was also an era of very tight labor markets. And tight labor markets typically lead to wage compression, that is, larger wage increases at the bottom than at the top.
You can clearly see this phenomenon in data from the Atlanta Fed’s Wage Growth Tracker, which among other things calculates annual hourly wage growth by quartile – quarters of the wage distribution:
As you can see, recent wage growth has been consistently faster for the lower quartiles. Over the past year, hourly wages in the first quartile, or lowest quartile, have nearly kept pace with inflation, while well below inflation for the highest paid workers.
The Labor Economist Arindrajit Dubey estimated the evolution of hourly wages – by decile rather than by quartile – over a longer period, since the start of the pandemic recession. He finds that the real wages of the bottom 40% of workers have actually increased:
A somewhat different measure comes from Realtime Inequality, led by economists at the University of California, Berkeley, which estimates changes in real factor income. Unlike hourly wage estimates, these figures are affected by changes in employment and the number of hours worked; they also include non-wage income such as business owner profits and investment returns. But they tell much the same story, significant gains for the bottom half of the income distribution since January 2021:
It’s true that the top 10% also performed well, which likely reflects higher profits. But again, the lowest paid workers seem to have done relatively well in the face of inflation.
So is the idea that inflation particularly hits low-income families a myth? Well, as I mentioned, there’s an asterisk here. We normally measure inflation using the Consumer Price Index, which tracks the cost of goods and services purchased by the average family. But low-income families spend a higher than average share of their income on food and energy, which are also the categories that have seen the most inflation recently:
My rough calculations suggest that even when these food and energy costs are taken into account, low-income families fare better, not worse, than others, at least in terms of the effects of inflation. . But that somewhat mitigates that difference.
And there is, as I also suggested, an asterisk on the asterisk. What we are really discussing is US policy – and the exceptional rise in food and energy prices is neither the result of US policy nor likely to be affected much by US policy in the future. In other words, if you want to blame the president for high food prices, the president you should blame is called Vladimir Putin.
None of this is to say the Fed shouldn’t try to bring inflation down. But you shouldn’t cite the plight of the poor as the reason for a lack of money. If anything, tight money, by causing more slack in labor markets and therefore more unemployment, will disproportionately hurt the lowest paid workers.
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