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May 15, 2024

Do Unexpected Inflationary Shocks Raise Workers’ Wages?

The past year’s steady decline in nominal wage growth now appears in danger of stalling. Given ongoing uncertainty in Ukraine and the Middle East, this seems an opportune moment to revisit the conventional wisdom about the relationship between inflation and wages: if an unexpected increase in energy costs drives up the cost of living, will workers demand higher wages, reversing the recent moderation in wage growth? In new work with Justin Bloesch and Seung Joo Lee examining those concerns, our analysis shows that the pass-through of such inflationary shocks to wages is weak. 

Wages and Inflation 

Historically, the consequences of an unexpected jump in prices were a valid concern. In the inflation episode of the 1970s, when a high share of workers were unionized and subject to bargaining agreements with automatic cost-of-living adjustments (COLAs), increases in the cost of living could certainly be expected to pass through to higher wages. This fostered concerns among policymakers about “wage-price spirals,” whereby higher inflation from an oil shock would result in workers demanding higher nominal wage increases, contributing to higher inflation in the non-energy sector as firms responded to higher wages by raising prices. However, today only about one in ten American workers is unionized, and there is little evidence that automatic COLAs are a prominent feature of modern labor contracts.  

So, should we expect wages to adjust today in response to an unexpected change in energy prices? Note that prior to the COVID pandemic, U.S. labor markets experienced large swings in commodity price inflation accompanied by negligible changes in wage growth. Consider the large decline in oil prices in 2015, documented below. This was caused by an increase in OPEC production in the fourth quarter of 2014.

Oil Prices Fell in 2015 after a Large Increase in OPEC Production 

Dollars per barrel

Source: Federal Reserve Bank of St. Louis Economic Data (FRED). 
Notes: This chart shows the large decline in spot crude oil prices, caused by a large increase in OPEC production in the fourth quarter of 2014. This coincided with a broad global decline in commodity prices in 2015.

The next chart plots these changes in the price of oil against changes in nominal wages, measured using the employment cost index for wage and salary workers. Aggregate U.S. wage inflation barely budged.  

As Oil Prices Fell, Wage Growth Barely Changed 

Percent, year over year

Percent, year over year

Source: Federal Reserve Bank of St. Louis Economic Data (FRED). 
Notes: This chart plots the year-over-year percent change in spot crude oil prices against the Employment Cost Index (Wages and Salaries) for all private U.S. workers.  

To explain this, Bloesch, Lee, and Weber (2024) study the theoretical pass-through of inflationary shocks to wages in a model where firms unilaterally post wages, rather than negotiate with unions, inspired by the fact that wage posting appears to be the predominant method of wage determination in the United States. Our model predicts that there is little reason for wage-posting firms to change wages in response to a “pure” inflationary supply shock that raises workers’ cost of living without affecting their productivity (for example, the price of food consumed at home or the price of energy consumed directly by households). 

To understand this result, note that wage-posting firms set wages while recognizing that offering a higher wage lowers their turnover costs by reducing the odds that their workers quit into unemployment or are poached by another firm. A wage-posting firm will thus raise wages if it perceives a heightened need to defend itself from losing employees to other firms or to unemployment. The key question then becomes: does an inflationary supply shock that raises workers’ cost of living as described above heighten these concerns?  

We think not. Even if a higher cost of living makes unemployment look more attractive (that is, if workers value additional leisure time more than a paycheck when inflation is high), in practice few American workers quit into unemployment, so firms primarily view other firms as their competition when posting wages. And if the cost of living is irrelevant to a worker choosing between wage offers at different firms, then an inflationary shock that raises the cost of living doesn’t make it any easier or harder for a higher-wage firm to poach workers than before. Thus, there will be no need for that firm to up its wage offers since an unexpected increase in the cost of living doesn’t make it any more likely that a firm will lose workers. 

While the mathematical model in Bloesch, Lee, and Weber (2024) is stylized, this theory of wage determination is consistent with a wide range of empirical facts. In particular, our model’s prediction that changes in the desirability of unemployment don’t matter much for wages is consistent with recent findings in Jager et al. (2020) that wages are insensitive to changes in unemployment benefits, even for workers who were hired directly from unemployment. Despite its simplicity, our model also features a reasonably realistic Wage Phillips Curve, which captures the fact that wage growth is more strongly correlated with deviations in the quit rate from its long-run value than with deviations in the unemployment rate. The fact that our model is consistent with these observations about modern labor markets makes us more confident in using it to understand the dynamics of wage inflation. 

In summary, while we may expect some pass-through in sectors where workers’ wages may be governed by union contracts with automatic COLAs, we expect that the pass-through of unexpected, inflationary supply shocks to wages is small for most American workers: when there is an unexpected increase in the price of something like energy, nominal wage inflation is largely unaffected, which means that real wages fall.  

Jacob P. Weber is a research economist in Macroeconomic and Monetary Studies in the Federal Reserve Bank of New York’s Research and Statistics Group. 

How to cite this post:
Jacob Weber, “Do Unexpected Inflationary Shocks Raise Workers’ Wages?,” Federal Reserve Bank of New York Liberty Street Economics, May 15, 2024,

The views expressed in this post are those of the author(s) and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the author(s).


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