U.S. workers have already been disempowered in the name of fighting inflation: Policymakers should not make it even worse by raising interest rates too aggressively


Earlier this year, debate over the inflation spike in 2021 polarized around the question of whether it was “transitory” or “persistent.” But it turns out that this was the wrong distinction. Instead, what should decide if the Federal Reserve is pushed into raising interest rates to cool off growth and tamp down inflation is whether this inflationary shock will be amplified or dampened in the labor market.

If it’s amplified, this means that wage increases will quickly follow price increases, as workers are able to protect their real (inflation-adjusted) wages from higher prices. Higher wage costs will in turn lead to firms raising prices again to protect their profit margins. This tit-for-tat escalation of wages and prices is what led policymakers to intervene decisively to cut short the famous inflation of the 1970s—sparked by a rise in oil prices but then amplified by these types of labor market dynamics.

If it’s dampened, then wage increases will lag price growth and workers will largely not be able to protect their real wages from the inflationary wave. This will reduce their wages but will also stem pressure for subsequent inflationary waves. The recent shock of price increases will hence be steadily smothered in the labor market, even if these price increases are relatively persistent.  

Exactly these dynamics are on the mind of policymakers. For example, U.S. Treasury Secretary Janet Yellen, when asked about inflation in recent testimony before Congress, responded: “What we don’t want to have develop is a wage-price spiral, in which inflation becomes its own self-reinforcing kind of phenomenon that would become chronic in the U.S. economy—something endemic.”

So far, there is little evidence that the labor market is amplifying inflation. The figure below looks at the recent acceleration in prices and wages across 110 industries. There is very little correlation to be seen. In sectors where inflation is high, like motor vehicle manufacturing, it’s generally not because wage growth is high. And in those sectors where labor scarcity has put upward pressure on wages, like hotels and other accommodations, it has not led to atypically fast price growth. In short, price inflation remains a problem coming from outside the labor market.

Price inflation and wage growth uncorrelated across 110 industries: Acceleration in producer price inflation and hourly earnings, December 2020–November 2021

Industry Price acceleration (ppt change) Wage acceleration (ppt change)
1133 9.17% 11.74%
2121 0.71% 2.64%
2122 15.40% 10.11%
2123 0.94% 0.89%
2211 21.85% 1.43%
2212 34.73% -9.74%
3113 3.57% -0.55%
3114 2.52% 4.55%
3115 5.78% 4.77%
3117 12.22% -0.70%
3118 2.73% 4.44%
3119 4.78% 11.66%
3211 3.80% 6.34%
3212 17.19% -3.83%
3219 19.38% 4.91%
3221 14.30% 2.70%
3222 10.81% 4.00%
3251 32.31% 0.58%
3252 35.41% -12.36%
3254 -1.24% 15.72%
3256 3.38% -6.59%
3259 7.89% 7.72%
3261 21.28% 2.90%
3262 7.69% 8.93%
3273 5.24% 2.61%
3279 7.96% 22.04%
3315 8.99% 1.28%
3321 41.39% 8.58%
3323 30.96% -3.19%
3324 16.57% -2.81%
3327 2.92% 0.99%
3328 8.32% 5.97%
3329 7.42% 5.40%
3331 3.84% -0.26%
3332 11.53% -6.88%
3333 5.03% -3.72%
3334 7.50% -1.68%
3335 1.04% 1.87%
3336 0.02% -11.49%
3339 6.68% 4.80%
3342 2.26% 3.36%
3344 3.78% 10.92%
3345 -0.68% 1.66%
3353 10.10% 9.62%
3359 12.85% -3.18%
3361 1.69% -5.44%
3362 12.15% 10.24%
3363 4.39% 0.50%
3364 -0.53% 2.43%
3371 11.20% -0.24%
3391 0.09% 4.31%
3399 0.69% 5.04%
4231 11.05% 3.80%
4232 25.99% -6.30%
4233 35.37% 2.09%
4234 7.51% 1.83%
4235 25.29% 2.40%
4236 16.94% 1.00%
4237 28.56% -2.42%
4238 -6.49% 2.81%
4239 11.51% 7.60%
4241 8.06% 2.34%
4242 -2.68% 5.57%
4243 -0.16% 2.59%
4244 -4.02% 2.60%
4245 0.00% -8.10%
4246 25.26% -5.09%
4247 37.54% 3.80%
4248 3.42% 5.45%
4249 -2.35% -2.53%
4411 30.74% 10.47%
4413 5.48% 7.01%
4421 11.21% 9.07%
4441 7.93% -4.44%
4442 3.03% -0.96%
4451 4.63% 7.11%
4452 8.52% -1.91%
4453 4.11% 12.02%
4481 22.85% 4.19%
4482 28.90% -6.62%
4483 7.97% 6.22%
4511 10.98% 3.84%
4512 -1.04% -7.23%
4532 10.76% 2.95%
4841 15.22% 0.64%
4842 7.77% -7.91%
4881 4.34% -2.29%
4883 1.91% -6.30%
4885 54.16% 11.28%
5111 0.74% 0.46%
5112 0.73% -7.06%
5173 -0.13% -6.52%
5221 -3.15% -5.54%
5241 -2.06% 0.73%
5312 7.71% 7.00%
5321 27.95% 8.03%
5411 1.50% 1.09%
5413 0.04% 3.43%
5416 21.86% 0.72%
5613 3.76% 8.25%
5621 1.22% 2.83%
6211 3.65% -0.42%
6212 0.73% 0.41%
6215 0.88% 5.25%
6216 -0.76% 3.11%
6221 0.53% 3.32%
6231 -4.37% 3.50%
7131 2.49% -8.01%
7211 13.59% 14.84%
8113 4.39% -3.50%
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