Working at home helped whip inflation

U.S. real wage growth has been tepid since 2021 in the face of low unemployment and historically high job openings.
U.S. real wage growth has been tepid since 2021 in the face of low unemployment and historically high job openings.

Summary

It boosted productivity and restrained wage growth. But now the Fed has to finish the job.

The U.S. inflation rate tumbled from June 2022 to June 2023. It was no slide down the Phillips curve of the sort that textbooks attribute to tighter monetary policy. Instead, inflation fell 6 percentage points as unemployment stayed low. It is thus a mistake to credit this episode to the Federal Reserve’s departure from low interest rates.

The timing is also wrong for a story that credits the central bank. From March 2022 to July 2023, the Fed raised its policy rate by 5 points. That’s a lot of tightening, but Milton Friedman taught us that monetary policy operates with “long and variable lags." For inflation, the lags usually range from nine months to two years.

Three developments explain the disinflation. The first is the lasting shift to remote work triggered by the pandemic. According to my research, full workdays at home were 28% of all paid workdays in June 2023, four times the estimated share for 2019. This shift has had surprisingly benign, even positive, effects on productivity.

Most people enjoy remote work because it’s convenient. The arrangement allows them to save time and money on commutes, and it affords more flexibility during the workday. On average, Americans value the option to work from home two or three days a week at 8% of pay.

Employees initially reaped the benefits of remote work, because their wages reflected pre-pandemic conditions and expectations. Over time, pay adjusted and employers adapted, eventually allowing them to benefit from slower wage growth.

My research quantifies this source of wage-growth moderation. Along with the Atlanta Fed, our team asked hundreds of business executives whether remote work affected their firms’ wages. Thirty-eight percent told us their companies had relied on the work-from-home boom to moderate wage-growth pressures in the previous 12 months. Forty-one percent said their firms planned to use remote work to restrain wage growth in the next 12 months. We found that the boom reduced overall wage growth by 2 percentage points from spring 2021 to spring 2023. In all likelihood, the effects extended beyond this interval, because pay adjusts slowly.

Remote work cuts costs in other ways, too. When employees work on site only two days a week, their companies need less space. Fully remote employees need no office space. Remote work also facilitates recruitment from locations with lower living costs and wages.

These observations explain another, otherwise puzzling development: U.S. real wage growth has been tepid since 2021 in the face of low unemployment and historically high job openings. This unusual wage-growth pattern arose partially because more workers accepted “compensation" in the form of more-desirable working arrangements.

The pandemic had other important effects on labor supply. Covid-19 caused more than an estimated 800,000 deaths and millions of hospitalizations in the U.S. in 2020 and 2021. Fear of the virus, along with social-distancing mandates and public-health warnings, reduced in-person work. This combination also led some working-age Americans to leave the labor force entirely.

In research with Jose Maria Barrero and Nick Bloom, I found that this drag on labor-force participation was concentrated among less-educated and older Americans, who had the most to fear from infection. We also reported that participation began to rebound in the spring of 2022, and perhaps earlier, as public-health worries began to wane. This rebound increased the labor supply, which helped restrain wage growth in 2022 and 2023.

The New York Fed’s index of global supply-chain pressures captures the third development. Transport costs and supply bottlenecks eased significantly throughout 2022 and the first half of 2023, reversing disruptions driven by the pandemic and its aftermath. Shipping costs for commodities fell, as did delivery times and backlogs for manufacturing components.

This came at a fortuitous time for the Fed, as it realized the gravity of its inflation problem. It shouldn’t bet on more good luck. Social distancing is over. The wage-growth restraint associated with remote work is largely played out, and real wages will return to their usual relationship with productivity and labor-market tightness. Supply-chain conditions are also back to normal.

The lesson? Good policy must finish the job of controlling inflation.

Mr. Davis is a senior fellow at the Hoover Institution and at the Stanford Institute for Economic Policy Research. He hosts “Economics, Applied," a biweekly podcast.

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