The impact of unexpected inflation on the labor market
In this paper, Afrouzi et al. develop a macroeconomic model to explore how inflation impacts labor market dynamics, wages, and worker welfare. The model includes nominal wage rigidities, heterogeneous workers, labor market frictions, and exogenous increases in price levels. Workers decide whether to renegotiate wages, search for new jobs, or quit and firms decide on layoffs based on profitability. The model is calibrated using pre-2020 U.S. data from sources like the Job Openings and Labor Turnover Survey (JOLTS), Current Population Survey (CPS), and payroll data and incorporates empirical patterns observed during the 2021–2024 U.S. inflation period.
Key findings:
- Labor market dynamics during inflation:
Inflation reduces real wages within existing employer-employee matches due to nominal wage stickiness. Workers respond by increasing job-to-job transitions and searching for better-paying jobs, leading to a rise in aggregate vacancies as a result the vacancy-to-unemployment ratio (V/U) increases significantly, creating the appearance of a “tight” labor market despite declining real wages. - Wage trends:
Real wages declined for workers across all income levels during the 2021–2024 inflation period, with higher-wage workers experiencing larger percentage declines relative to trend. But job-changers saw greater nominal wage growth compared to job-stayers, reflecting their ability to negotiate better terms in new matches. - Welfare impacts:
Inflation reduced worker welfare primarily through real wage declines. Higher-income workers suffered greater welfare losses due to their lower elasticity of response to labor market shocks. Increased job search and renegotiation costs further diminished worker welfare but were partially offset by reduced layoffs. - Historical validation:
The model aligns with historical data from 1950–2019, showing that periods of high inflation were consistently associated with elevated V/U ratios and upward shifts in the Beveridge Curve (the relationship between unemployment and vacancies). - Comparison with alternative theories:
Other explanations for tight labor markets (e.g., productivity shocks or reduced vacancy posting costs) fail to replicate the observed combination of rising V/U ratios, declining real wages, and increased job-to-job flows during inflationary periods. - Policy implications:
The findings caution against interpreting high V/U ratios during inflation as evidence of a “hot” labor market benefiting workers. Instead, inflation-driven dynamics can harm workers by eroding real wages while increasing churn and search costs. - Firm outcomes:
Firms benefit from inflation as their market power increases due to reduced real wage costs for existing employees. This is consistent with observed high corporate profit margins during 2021–2023.
A Theory of How Workers Keep Up With Inflation
Authors: Hassan Afrouzi, Andres Blanco, Andres Drenik, Erik Hurst
From: Columbia University, FRB Atlanta, UT Austin, Chicago Booth
Unexpected inflation and workers’ conflict costs
Guerreiro et al. investigate why workers dislike inflation, focusing on the role of conflict between workers and employers over wage adjustments. The authors develop a “conflict cost” model, where workers choose between accepting a default wage offer or engaging in costly conflict to secure higher wages. They then conduct a survey of 3,000 US workers in early 2024 and use cross-country panel data to examine the relationship between inflation and labor market strikes
Key findings:
- Importance of conflict:
– 21% of workers reported taking costly actions to secure wage increases in 2023.
– Workers who engaged in conflict believed it raised their wages by 3 percentage points on average.
– Those who didn’t engage in conflict believed it would have raised their wages by 2 percentage points. - Relationship between inflation and conflict:
– Survey evidence shows workers are more likely to engage in conflict when inflation is higher.
– Cross-country data reveals a positive correlation between inflation and labor market strikes. - Welfare costs of inflation:
– The model shows that wage catch-up resulting from more frequent conflict does not raise welfare.
– The impact of inflation on worker welfare is determined by “wage erosion” – how inflation would lower real wages if workers’ conflict decisions did not respond to inflation. - Quantification of conflict costs:
– The median worker would sacrifice 1.75% of their wage to avoid conflict with employers.
– Employers’ wage offers are weakly indexed to inflation, with a 0.05 percentage point increase in wage offers for every percentage point increase in inflation. - Implications for inflation costs:
– Incorporating conflict more than doubles the overall costs of inflation to workers compared to considering only falling real wages.
– This result holds for both transitory and persistent inflation shocks, as well as for the post-pandemic inflation of 2021-2023.
Why Do Workers Dislike Inflation? Wage Erosion and Conflict Costs
Authors: Joao Guerreiro, Jonathon Hazell, Chen Lian, Christina Patterson
From: UCLA, LSE, UC Berkeley, University of Chicago
