An Industry Look at Wage Growth & Inflation

Executive Summary

Wage growth has trended higher as the expansion has matured. While the relationship between labor market slack and inflation is weaker than it once was, it is still significant. Further, the relationship differs by industry. Industries where labor accounts for a high share of input costs tend to be more exposed to higher inflation from rising wages. Wages and inflation are not linked across all industries, but do bear a positive relationship in a few key industries. Healthcare services and housing are the most notable industries to watch. Not only are prices in these industries closely linked to rising wages, but given their large weight in the PCE deflator, firmer earnings growth could lead to meaningful upward pressure on inflation.

Does Something Gotta Give?

The risk that a tight labor market sets off inflation appears low in the minds of both investors and monetary policy makers. The gap in yields between traditional Treasury securities and Treasury Inflation Protected Securities (TIPS) are near historic lows, while FOMC members expect inflation will continue to undershoot the committee’s 2% target this year. The tepid view comes as inflation has struggled to gain traction despite a tight labor market (Figure 1). The relationship between labor market slack and inflation—commonly referred to as the Phillips Curve—has weakened in recent decades.Instead, inflation expectations, technology and globalization have taken on a greater role in inflation dynamics. 

That said, stronger wage growth is still tied to higher inflation, even if the relationship between labor market slack and price growth has generally weakened. Despite some loss of momentum the past few months, wage growth has trended higher as the expansion has matured. Average hourly earnings for production and nonsupervisory workers are up 3.3% over the past year compared to an annualized rate of 2.3% from 2010-2018. Wage growth has been particularly strong in lowerpaying industries amid revived demand for workers (Figure 2). While the tight labor market has only a modest effect on overall inflation, are prices in some industries particularly vulnerable to rising wages?

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