Getting Real About Wages: A Nonhomothetic Wage Deflator

Abstract

Conventional real wages—nominal wages divided by a consumption deflator—are biased from a welfare perspective when households value leisure and exhibit nonhomothetic consumption behavior. We derive a true wage deflator, shown to be a multiplicative adjustment to the consumption deflator, that can be estimated nonparametrically using cross-sectional data. Applying our framework to US data from 1984 to 2019, we find that standard measures understate real wage growth by 8–36 percent and welfare growth by 5–17 percent across the income distribution. Our deflator does not alter the compression of the wage distribution during the recent high-inflation period, however.