Real wages help people understand their purchasing power by taking into account inflation.
What Are Real Wages?
Real wages, or real earnings, represent pay after accounting for inflation. Gains in real wages on a monthly basis can help in analyzing other economic indicators such as inflation.
When people feel they have more disposable income at hand, they are likely to spend more, and conversely are likely to spend less when money is tight. At the same time, employers could feel pressure to raise pay if wage gains match or are less than the inflation rate.
Nominal vs Real Wages
The key to understanding real wages is understanding nominal wages first. Nominal wages reflect pay on an hourly or salary basis. It’s the amount of money that is received in a particular period, be it weekly, monthly, or semi-monthly.
If the prices of goods and services remain steady, a worker should be able to sufficiently pay for those goods or services without having to worry about rising costs. However, if prices rise quickly, then a worker would end up paying more out of their nominal wages than they are used to.
Accounting for the rate of inflation in the calculation of real wages provides a more accurate indication of purchasing power.
Why Are Real Wages Important?
Real wages are a useful way to understand how inflation affects employees. Workers who are negotiating wages can point to inflation as an excuse for higher pay. Real wages are also indicative of purchasing power—how much is being paid for a particular good or service taking into account the rising costs of goods and services overall, especially when inflation suddenly accelerates.
Workers typically clamor for an increase in pay from their employers, arguing that everyday items—such as gasoline, meat, and bread—have become more expensive, and that leaves them with less income to spend on other essential goods and services. Just as inflation is viewed as a lagging economic indicator, the same applies to real wages.
Below is a graph by quarter from the first quarter of 1979 to the second quarter of 2022 showing median usual weekly real earnings, adjusted for inflation, in dollars, for people working full time.
The data showed that real wages increased in the months leading up to the COVID-19 pandemic in early 2020, but dropped significantly soon after as inflation started to accelerate. The data also showed that earnings tended to take a dip following periods of recession.
Real earnings tend to take a dip following periods of recession.
Screenshot via Federal Reserve Bank of St. Louis
Source: Screenshot via Federal Reserve Bank of St. Louis
Most investors and analysts tend to focus on the month-on-month real earnings data of workers in the private sector published monthly by the Bureau of Labor Statistics. The bureau also releases useful wage information beyond the headline numbers based on the federal government survey that provides estimates on unemployment known as the Current Population Survey (CPS), which covers about 60,000 households. Earnings are broken down by demographics, education, occupation and industry, union membership, and working poor.
How to Calculate Real Wages
The simplest way to calculate real wages is by subtracting inflation from nominal wages. In the Bureau of Labor Statistics’ method of calculating, that means taking the month-on-month change in nominal wages, or average weekly earnings, minus the month-on-month inflation rate, which is the change in the consumer price index from month to month.
For example, average weekly earnings in a particular month rose 0.8 percent, while the consumer price index gained 0.6 percent. That means real earnings rose 0.2 percent, much less than the nominal rate increase without taking into account the inflation rate.
Inflation plays a significant role in determining the actual value, or purchasing power, of wages. When inflation moves faster than the pace of nominal wages, people feel less wealthy, and that could push them to spend less, which, in turn, might cause economic growth to slow.
Formula
Real Wages = Nominal Wages (Month-on-Month Change) — Inflation Rate (Month-on-Month Change)
Real Wages = Nominal Wages (Month-on-Month Change) — Inflation Rate (Month-on-Month Change)
When Are Real Wages Released?
The Bureau of Labor Statistics usually releases monthly data on real wages toward the middle of the month. The formal title of its press release is Real Earnings Summary. The report focuses on real average weekly earnings and the consumer price index.
