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10 07 2015 | by Victor Xing | Economics

Has real income been gradually rising in the U.S.?

Real income growth

Real income has been gradually rising in the U.S. for the top 5% and top quintile, but the real income growth rate for the 2nd quintile and below has been disappointingly soft (growing, but at 0.45% annualized real growth rate).

Source: Doug Short

Real income growth
Real income growth

There are several factors behind the sluggish wage growth (for all quintiles over the past decade)

Asset price inflation and its asymmetrical effects on real wage growth

At the height of the financial crisis of 2007–08, Federal Reserve began its extraordinary monetary policy easing to combat the clear and present danger of deflation, seen in the form of rapid private sector deleveraging, by lowering its rates close to zero and started 3 rounds of quantitative easing.

However, rates at zero lower bound is a form of financial repression.  Non-asset holders were punished – their bank deposits now generate little or no income, and they were forced to move into riskier assets, such as stocks, bonds, real estate, or “anything that offers some yield and is not bolted down to the floor” (please see my answer to What kind of market distortions does the Fed loaning out money at 0% cause?).  This led to asset price inflation.

In the following chart, you will see a steadily recovery in house prices, as well as a corresponding decline in the affordability index.  The red line is OER, or Owners’ Equivalent Rent (a proxy for rental cost), accounting for 24% of the Consumer Price Index.  This component is now at 3% YoY, and it has been eating away household real income.

OER is not an issue for home owners, as it is positively correlated with house price appreciation (HPA).  It does, however, have a vicious impact on lower income earners who cannot afford to buy a house – they become perceptual renters.  The more renters, the higher the rental cost.

In short, asset price inflation is disadvantageous to those without asset (young workers, low income workers, retirees relying on low risk fixed income products), and it benefits asset holders (who tend to be more affluent)

Job polarization and the hollowing out of the middle class

The U.S. labor market is undergoing structural changes.  New York Fed researchers highlighted that job polarization is an on-going trend in the labor market.  This is contributing to the growing income gap, and further weigh on real wages of lower income earners (who will likely be paying higher rents, in the form of higher OER).

Job polarization
Job polarization

In conclusion, aggregate real income has been gradually rising, but it is rising much more slowly for low income workers.

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