Heat of the Market: The Illusion of a Simple Solution for Wages

That 'one simple trick' for raising wages is not so simple after all.

“One simple trick for raising wages,” according to Oren Cass’ American Compass, is to run the labor market hot. There’s just one problem — it’s not that simple. A hot labor market puts upward pressure on wages but also threatens inflation. And inflation hurts everyone by eroding real wages.

A “hot” labor market is typically characterized by many job openings and not enough qualified workers to fill them. The federal Bureau of Labor Statistics (BLS) tracks these data and reports the number of unemployed people per job opening. As of October 2023, that figure was 0.7. In other words, for every seven people seeking employment, there were 10 job openings. By this measure, you could say the labor market is running hot.

In recessions, the number of unemployed workers per job opening can reach fairly high levels. During the 2008 recession, this ratio reached 6.5. During COVID it reached 4.9. There is not necessarily an optimal level. The average is 1.35 for the last 20 years.

A 1-to-1 ratio would mean that for every unemployed person there is one job opening. But to put these figures in perspective, there is a lot of churn in our labor market each month and that’s a good thing. For instance, in November there were 5.5 million hires and 5.3 million separations (e.g., quits, layoffs, quits and retirements). These dynamics reflect the “creative destruction” in the labor market that contribute to a dynamic and resilient economy and labor force. The economy with a dynamic labor market “sheds” jobs it no longer needs and “creates” the new ones it does. On average, workers are better off for it as they adjust to the demand for new skills and their real wages increase. 

The US labor market was running hot right before Covid and has been running even hotter since the recovery. In January 2020 (right before Covid hit), the unemployed-to-job-opening ratio was 0.8. Once Covid hit, it spiked to 4.9 and then came back down and reverted to trend. By June 2021, employers were desperate for workers. Nearly 20% of all jobs posted on job search site ZipRecruiter offered a signing bonus with reports of poultry processing plants and fast-food restaurants offering a $1,500 bonuses. The labor market has continued to run hot (the ratio far below one). By early 2022 the ratio hit a low of 0.5, which means that for every 10 jobs available, only five people were looking for work.

A hot labor market may sound good if you are the one looking for a job. But higher wages are typically followed by higher prices. Data show wages have increased but prices have increased even more, and real wages have remained flat and even slightly declined.

Figure 2 shows consumer sentiment, the PCE price index, unemployment rate and real earnings from January 2020 to November 2023. The data are indexed to January 2020 in order to more easily see relative changes over this period. Since Covid, employment has recovered, but real earnings have remained flat and even slightly declined. Inflation has increased and consumer sentiment has deteriorated. The relationship between inflation and consumer sentiment is well-known. Even with the labor market running hot—a low number of unemployed persons per job opening and low unemployment rate—real earnings have remained flat and the country’s economic mood has deteriorated.

So that “one simple trick” to raise wages is not so simple after all. With inflation, your wages don’t go as far as they used to and that may at least partially explain the country’s worsening economic mood Since January 2020 (deteriorating consumer sentiment index).

Instead, a dynamic labor market with healthy levels of job churn is more likely to bring about a resilient labor force, real wage gains and economic growth.