Main Street Macro: What the pay gap says about inflation

One of the puzzles of today’s economy is inflation: Why isn’t it falling as fast as economists or the Federal Reserve expected? Inflation has slowed a lot over the past year, but recently it has stubbornly defied expectations of further declines.

Last week, Fed Chair Jerome Powell summarized this conundrum after the central bank’s policy meeting, citing “a lack of further progress” toward the bank’s 2 percent inflation target.

Recent inflation has been sticky lately for several reasons, one of which might be tied to wages. In a new analysis, the ADP Research Institute’s Liv Wang shows how wage growth among the highest and lowest earners has helped chart the course of inflation since the pandemic.

We analyzed payroll data from 13 million workers by income level. Here’s what we found.

Rapid wage growth since the pandemic

Supercharged pay growth has been a defining factor in the labor market since the pandemic-driven economic downturn.

Year-over-year pay gains for the lowest paid workers peaked in March 2022 at 16.1 percent. Pay gains for the highest earners reached a high of 5.8 percent in May 2022.

Low-wage workers saw big pay jumps. High earners did even better.

One reason low-wage earners saw big percentage gains is because they started from a small base. While their pay growth surged relative to their higher-paid cohorts, growth in the actual amount of pay—the pay level—told a different story.

For the lowest earners, median year-over-year pay gains peaked at $2,936 in March 2022. For the highest earners, those annualized pay increases peaked in October 2022 at $7,387, more than double the increase for lowest earners.

More low-wage earners are young, female, and customer-facing

Sixty percent of workers in the bottom quartile of earners are female, compared to 33 percent in the top quartile, according to March data.

Workers in the top quartile are concentrated in information, professional and business services, and finance. The lowest paid are clustered in leisure and hospitality and education and health services. The latter two industries have posted the largest job gains of the post-pandemic era.

My take

Last week’s Pay Insights report from ADP showed that year-over-year pay for job-stayers grew 5 percent in April, down from 5.1 percent in March. While pay growth continues to ebb, it’s decelerating much more slowly than it was a year ago.

This pattern of higher earners benefiting more from pay gains has the potential to direct the path of inflation by encouraging more discretionary spending among these households.

While low-wage earners have seen bigger relative increases in pay since the pandemic shutdown, they also spend a larger share of their income on food, housing, and other necessities, all of which have grown more expensive.

High earners have not only bigger pay increases, they have a greater ability to spend on discretionary purchases such as vacations and concert tickets.

That discretionary spending has helped the economy grow, but it brings with it higher demand for goods and services, which helps fuel inflation.

These findings help explain a component of our higher-for-longer U.S. inflation.