WASHINGTON • The stagnation in wages despite a pickup in hiring over the past few years has been one of the recovery's most perplexing puzzles. But maybe the real problem isn't lack of growth. It's that wages didn't fall enough during the recession.
That idea was floated by none other than Federal Reserve Chair Janet Yellen during a speech on the labor market last month during an elite central banking conference in Jackson Hole, Wyo. She used a much fancier term — "pent-up wage deflation" — but it essentially means that employers are keeping workers' pay flat now to make up for not cutting it during the downturn.
Yellen was citing recent research by San Francisco Fed economists Mary Daly and Bart Hobijn that outlined these dynamics. It starts with the theory that firms would rather lay off workers than cut employee pay when times get tough. That's because employers want to contain the pain to those who are leaving and keep the remaining workers as happy as possible.
In fact, businesses are much more likely to raise workers' wages than to reduce them, according to the San Francisco Fed. But the action they are most likely to take is no action at all, leaving your earnings unchanged. Economists call this "downward nominal wage rigidity."
This is particularly true during downturns and their immediate aftermath. Looking at data back to the 1980s, Daly and Hobijn found that the unemployment rate spikes more rapidly during recessions than the number of workers whose pay flatlines. However, wage stagnation remains high even after the jobless rate begins to fall.
That's where pent-up wage deflation comes in. By leaving workers' wages unchanged during the recession, businesses were essentially overpaying their employees. Once the recovery starts, they make up the difference the same way — keeping wages flat despite an improving economy.
Normally, rising inflation during a recovery helps businesses reduce costs even if wages remain unchanged. But the recovery from the Great Recession has been characterized by particularly low inflation — which is likely lengthening the time firms need to keep wages flat.
"This just becomes a more binding concept," Daly said in an interview.
When will this period of pent-up wage deflation end? The next clue will come Friday when the government releases its monthly report on the health of the labor market, including average hourly earnings for private employees. They stood at $24.45 in July, up 2 percent over the previous year — the same rate at which it has been stuck for a while.
But once it runs its course, wages could rise more quickly than traditional economics models suggest, the researchers said. In other words, businesses that were slow to adjust worker pay to the improving economy might suddenly find themselves playing catch-up.