The Economy, Jobs, and Inflation Explained: What Americans Need to Know

Some people say that “inflation” is one of the most misused words in economics. How is inflation distinct from or related to increases in prices?

Zaber Inflation is a rate of change. So one common mistake is to think that when inflation drops, prices should drop. But what that really means is that prices are still increasing, just more slowly. The most commonly used price index to measure inflation is the Consumer Price Index (CPI), which tracks the cost of goods households typically buy. It's also important to know that the CPI exclusively tracks price changes in urban areas.

Wenger Prices can rise for fundamental economic reasons. Typically a reduction in supply or an increase in demand for a good or service will be accompanied by an increase in the price, though not instantaneously. That's not inflation; it is just supply and demand doing their thing. Inflation occurs when there is a general increase in prices across the entire economy. This is almost always due to too much money chasing too few goods.

During the COVID-19 pandemic a combination of things happened—some basic supply-and-demand economics, some inflationary. People initially shifted away from consumption of services such as haircuts, massages, restaurant meals, etc., because of the risk of catching the virus. This is a demand shock: a shift in preferences based on new information (e.g., eating in a crowded restaurant is dangerous!). Typically the market adjusts and a new equilibrium is found. But three things conspired to prolong price increases: The shift towards goods and away from services was larger than analysts anticipated, the supply chains became overburdened, and the government's pandemic relief checks increased the amount of money people had to spend. All of these raised prices—the first was a massive demand shift, the second was congestion, and the third was general inflation.

How does inflation hit working-, middle-, or upper-class households differently?

Wenger Inflation hits people differently not because of their income level, but because of the kinds of things they buy. Upper-income households typically spend more on services and generally save a portion of their incomes. Working- and middle-class households spend a larger share of their income on necessities: food, shelter, transportation, clothing, etc. That makes it more difficult for them to avoid inflation. How hard inflation hits also depends on the age and family composition of the household. Families with young children face staggeringly large childcare costs—so a small percentage increase in that results in large dollar amounts. The same goes for college costs. Older families may face high medical bills and caregiver costs.

Finally, we should say something about households with debt—especially if that debt is at a fixed rate, like many mortgages. These households will face higher costs in their daily consumption, but if their incomes increase (to offset inflation), then they are ultimately better off because they pay back the loan with inflated dollars.

“The economy” always tops the list of voter concerns before a national election. Can results from any one election shape the whole economy?

Wenger Yes. Congress and the president can have an enormous impact on the economy via taxes and spending. The president can levy tariffs on imported goods, which effectively raises their price. An across-the-board tariff would almost certainly raise prices in an inflationary way.

Zaber I'd mostly agree. The economy can have momentum in a particular direction heading into an election, but our elected officials can shape domestic spending, revenue mechanisms, trade policy, and international engagements that all affect U.S. economic prospects. Perceptions of elections and of government stability also affect consumer sentiment, which shapes valuations in the stock market.

The COVID-era worker shortages caused some wages to go up. How have those increases held up relative to inflation?

Zaber Can I answer with a graph from the St. Louis Fed? Real earnings—wages that take inflation into account—spiked during 2020, but then fell through the middle of 2022. That doesn't mean people got fewer dollars in their paycheck, just that the buying power of their wages went down. But we've seen fairly steady increases in real earnings since then, at least at the median. One important caveat: This data reflects just full-time workers.

Wenger Difficult to say. Full-time workers in the middle of the earnings distribution (median) are now earning more money (in inflation-adjusted terms) than they did just prior to the pandemic. Average hourly earnings for production, nonsupervisory workers are higher now, too. However, it was only in 2023 that inflation-adjusted household income finally bounced back higher ($80,610) than it was in 2019 ($78,250).

Updated employment reports show American businesses added fewer positions than thought from April 2023 to March 2024. What are you keeping an eye on in terms of jobs in the months ahead?

Wenger I typically keep an eye on three or four indicators: employment growth, the unemployment rate, weekly claims for unemployment insurance, and employment in the temporary help industry. As already pointed out, employment growth was weaker than initially reported (although still a good amount of job growth). Unemployment has been ticking upwards to a current rate of 4.2 percent in August 2024. Initial claims for unemployment insurance have been ticking upward since January 2024, which is again cause for concern. Finally, temporary help employment has been on a steady decline since March 2022. This is almost perfectly coincident with the Federal Reserve raising its interest rate target from 0–.25 percent to 5.0–5.25 percent in 10 rate hikes from March 2022 to June 2023. This led to a cooling of the labor market as evidenced by the economic data series discussed above.

Zaber I'd add the labor force participation rate to Jeff's list above. With prior recessions, we've seen unemployed workers become discouraged and exit the labor force, whether to retirement, disability, or uncompensated household labor. If the labor market improves enough (i.e., unemployment dips, wages rise) to entice more people to join or rejoin the labor force, we might actually see a temporary bump up in the unemployment rate. That's because we'll have more potential workers, and more of them looking for jobs.

Surveys show increasing percentages of people feel the “American Dream” is out of reach. Are there policies to consider that could reverse this trend?

Wenger Housing, education, health care, childcare, and eldercare are devouring large portions of U.S. households' budgets. That's preventing folks from saving more and attaining a middle-class lifestyle. There are direct policies that federal, state, and local governments could adopt. For example, there are 10 states that have not expanded Medicaid for the poorest households (133 percent of poverty line), in accordance with provisions in the Affordable Care Act. State and local governments have done little to reduce the administrative burden of building single- or multi-family housing. Policy solutions for lowering the cost of education, childcare, and eldercare have been limited, but all essentially rely on creating a public system of supply via taxes and program expenditures, so that one family is not wholly responsible for them.

What is more difficult to change are the structural dimensions of the economy, in particular wealth inequality. It is currently the case that the top 1 percent of households hold as much wealth as the 40 percent whose wealth puts them in 50th to the 90th percentile. Each group controls about 30 percent of the net worth of the United States. This structural issue has been connected with a lack of economic mobility for the bottom half of the wealth distribution.

Zaber I'd argue that some of this is moving the goalposts. Is the American dream “rags to riches” in a generation, or just the ability to better yourself and your children through hard work? There's a lot of focus on the decline in homeownership, which was long seen as a milestone during early to mid-adulthood. But some recent research at the Fed (PDF) suggests that at least in terms of income, American young adults (yes, even millennials) are continuing to do better than their parents did, while working fewer hours.

Still, there are policies the United States could adopt that would likely support upward economic mobility and provide more stability. We focus a lot on building ladders—supporting postsecondary education, moving folks to better communities, and providing access to capital to start a business. We don't focus so much on protecting people from the chutes—sudden unemployment, health complications or disability, and incarceration—and providing ways to reenter from them.

Many suggest that artificial intelligence (AI) and large language model (LLM) technologies are going to bring major changes to the employment landscape. If you were giving advice to high school seniors right now, what would you tell them?

Zaber The ability to seek information and evaluate the quality of sources is a perennial skill, and that is doubly true in this early phase of generative AI adoption. Learning how to do this while using AI tools will put you ahead of the curve.

I do anticipate that AI will have an effect on work, but for many jobs, this will come in the form of changing what a job looks like rather than eliminating it altogether. Non-routine cognitive jobs will be least impacted, so consider jobs that require thinking and some variety like management, business and financial operations, and engineering.

Wenger I think AI/LLMs are going to have a large impact on the kinds of jobs that had been resistant to prior waves of technology. Previously, jobs that required doing the same task over and over, like working on an assembly line, were largely automated through robotics. Now the AI/LLMs are coming for more cognitive and creative tasks. The AI/LLMs are able to summarize, analyze, and evaluate large amounts of text in ways that, before, only the human brain could do. Occupations such as editors and proofreaders, paralegals, translators, insurance adjusters, accountants, customer service representatives, programmers, journalists, and a host of other jobs will be impacted. Those at the pinnacle of the professions are unlikely to be affected because they will have to use judgment and expert knowledge to make decisions on difficult cases.

Political candidates often tout their ideas about income tax policies, suggesting that these will benefit the middle class or most Americans. How effective a policy lever are federal income taxes, or what are their limitations?

Wenger Federal income taxes leave vast amounts of wealth untaxed. In economic parlance, they have a “small base.” Total earned income in the United States in 2023 was approximately $23 trillion (yes, with a 'T'!). But American-held wealth was about $156 trillion. So earnings represents only a small fraction (about 15 percent) of the total base on which to levy taxes.

Additionally, things that seem like income (like gains from stock trades) are not really labor income and are typically subject to lower tax rates than income taxes. Finally, we have the top 20 percent of earners taking home about half (47 percent in 2016) of all the earnings. So in order to generate significant revenue primarily from income taxes, the government has to tax the rich—because “that's where the money is.” Good tax policy (according to economists) calls for broadening the tax base and lowering the rates—but that's not what federal income tax system is accomplishing.

Zaber Tax discussions during elections tend to focus on who is getting taxed and how much (or how little!), not on how the taxes themselves get used. Income taxes exist to raise revenue for the government to fund its activities and programs; taxes on individual income make up a little over half of that revenue. Payroll taxes (which fund entitlement programs) are the next-largest source of revenue; corporate income tax revenue is a much smaller slice. Cutting rates for any of these taxes limits the federal government's ability to fund its programs. Increasing tax rates can augment that ability; alternatively, so can efforts to increase compliance with the existing tax code (a different version of Jeff's proposal to broaden the base).