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Economists Have Failed Middle-Class Americans

Without anyone paying much notice, our collective overreliance on wage data has had the perverse effect of allowing prices to rise even as earnings remained stagnant.

(Bloomberg Opinion) --  When inflation finally comes under control, everyone will rightfully celebrate. But even as Washington and Wall Street collectively exhale, policymakers will need to take some time to understand why 2021’s prevailing economic wisdom proved so wrong.

Recall that, while some raised red flags, the popular view among those steering the economy was that rising costs would abate upon repair of the global supply chain. That notion spurred the Federal Reserve to make more measured interest rate hikes than they might have done with the benefit of hindsight. The reflection is less an indictment than an insight: It’s time for Washington to revise the way it interprets time-honored economic indicators. 

What we should all hope is that 2021 turns out to be a teachable moment — and that everyone takes the lessons to heart. Broadly speaking, the field of economics was thrown off course by its longstanding maxim that wages are the most reliable indication of deep-set inflation.

Policymakers were put at a disadvantage in 2021 because wages remained stable during the early months of the inflationary wave even as indicators like consumer prices, consumer spending and rates of disposable savings were flashing red, particularly in respect of the goods and services most important for the well-being of middle- and low-income Americans. Moving forward, analysts will need to remember to broaden their frame, or at least to throw off the blinders that steered our collective wisdom the wrong way. 

But the problem actually wasn’t altogether new — 2021 simply exposed what we now know is a broader and deeper concern. Without anyone paying much notice, our collective overreliance on wage data has had the perverse effect of allowing prices to rise even as earnings remained stagnant, a shift that made it harder for ordinary people to maintain a steady lifestyle. If the price for milk, gasoline and housing rise without commensurate hikes in pay, ordinary families are robbed of their spending power. And yet monetary policymakers have been disinclined to intervene without clear evidence of accelerating wage increases.

As research by the Ludwig Institute for Shared Economic Prosperity reveals, in 2021 alone, living costs rose 6.1% for middle-class families even as nominal wages for a typical full-time worker rose only 1.4%. Perhaps of even more concern, over the last 20 years, the true cost of living for middle- and lower-income Americans has risen 50% more than commonly used measures like the Consumer Price Index. And that reflects the same core problem born from our overreliance on wage data: The CPI overemphasizes the more modest price increases that persist for goods and services targeted more exclusively to the well-off, even as wages have risen much more modestly. In both cases, policymakers responding based on their traditional reliance on prevailing indicators have been shielded from the harrowing fates that have befallen low-income and working-class families. 

Sometimes when citizens complain that the government is not adequately considering their well-being, they back up their claims with thin gruel. But here the evidence is clear. The world of economics has taken an approach that has lamentably put the interests of those responsible for paying hourly wages above the interests of those who earn them. Fortunately, however, that’s driven less from a desire to pick winners and losers within the economy than a mistaken presumption that wage data represent some sort of statistical holy grail. And for that reason, the shock born from 2021 should spur an expeditious correction. 

To counteract this wage-oriented dynamic, the world of economics should begin supplying the Fed and other policymakers with predictive modeling that places more emphasis on prices, consumer demand and disposable income levels, particularly for middle- and lower-income Americans. Second, Congress should begin taking the net effect of that data — the pervasive and real concerns that ordinary people have when inflation makes them poorer — to heart when shaping the nation’s social safety net.

Finally, Americans generally need to take a different view of inflation. What matters most is not any single price for any given product or service, but whether the typical family is more or less equipped to cover the cost. Rising prices are even more of a problem when wages are not rising at a commensurate pace with the price of other necessary goods and services.

The US can’t endure an endless spiral in which the middle-class family is perpetually made poorer. To reverse course, we first need to acknowledge that the mistakes of 2021 were not born of malice but of misperception.

We already have at our disposal new ways to understand and interpret statistics that better reflect both present and future realities for people’s financial lives. To make the right course correction, the world of economics will need to adjust its bearings. Hopefully, the short-term shocks wrought by this latest episode of widespread economic turbulence will help policymakers steer a course to smoother sailing in the future.

More From Other Writers at Bloomberg Opinion:

  • Why the Fed Should Raise Rates 50 Basis Points: Mohamed El-Erian
  • Economists Now Have a Good Excuse for Being Wrong: Tyler Cowen
  • Dumb, Dumber and Leading Economic Indicators: John Authers

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To contact the authors of this story:
Eugene Ludwig at [email protected]
Philip Cornell at [email protected]

© 2023 Bloomberg L.P.

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