Gain In U.S. Workers' Wages In 2023 To Surpass Inflation Rate

US workers lost ground this year as their wages did not keep up with inflation, but they should regain some of those losses in 2023. Forecasters project that inflation will decline next year.

Photo Insert: Forecasters project that inflation will decline next year.

There is considerable disagreement over the size of the reduction since it is uncertain how fast the hot economy and labor market will cool off. But whatever happens to the labor market, inflation is likely to fall far below wage growth in 2023, Joseph E. Gagnon and Asher Rose of the Peterson Institute for International Economics (PIIE) reported.

The latest Survey of Professional Forecasters projects a rapid slowdown of inflation from 5.9 percent in 2022 (Q4/Q4) to 2.9 percent in 2023, followed by a modest decline in 2024 to 2.3 percent.

The 2024 projection is reasonably close to the Federal Reserve’s inflation target of 2 percent. Inflation is defined here in terms of the personal consumption expenditures (PCE) price index, which the Fed targets.

The rate of unemployment, at 3.7 percent, is only slightly below the Federal Reserve’s estimate of the long-run equilibrium rate of 4 percent. However, it is likely that the COVID-19 pandemic significantly raised the equilibrium rate and that it is only slowly returning toward 4 percent. The historically high job vacancy rate is one of several indicators pointing to an overheated labor market.

Professional forecasters currently expect the unemployment rate to rise to 4.3 percent by Q3 of next year and 4.4 percent by Q4. Vacancies are likely to be much lower by then, consistent with a labor market that is close to equilibrium. If so, labor costs should slow dramatically.

That’s because research shows that growth of the employment cost index (ECI) moves rapidly toward about 3 percent once the unemployment rate reaches its equilibrium level.

Over the 20 years prior to the COVID-19 pandemic, the PCE inflation rate averaged about 0.8 percentage point lower than the ECI growth rate, so that an ECI growth rate at or just below 3 percent would be consistent with a PCE inflation rate of about 2 percent.

If the equilibrium rate of unemployment is higher than next year’s actual rate, the ECI growth rate will not decline to near 3 percent. Indeed, professional forecasters expect ECI to rise 4.3 percent in 2023 relative to 2022. Twelve-month ECI growth peaked at 5.4 percent in June 2022 and declined to 5.1 percent as of September.

In the projection, ECI rises at an annualized pace of 5 percent from September 2022 to March 2023, 4.5 percent from March to December 2023, and 4 percent in 2024.

This projection is consistent with only a modest cooling in the labor market and an unemployment rate still somewhat lower than its equilibrium rate. Further reductions in inflation beyond 2024 would require ECI growth to slow well below a 4 percent pace.

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