Wage Inequality Decreased Dramatically in the 1940s. But Was This “Great Compression” a Mirage?

But was the Great Compression really so … great? Or was it more theoretical than real?

After all, inflation was rampant during the WWII era. From 1940 to 1950, the Consumer Price Index rose by 72 percent—an average annual inflation rate of more than 5 percent per year. Goldin and Margo assumed that all households experienced similar changes to their purchasing power over this era. But if lower-income households were hit much harder by inflation than higher-income households—as has been the case in more recent decades—then the extent to which households truly experienced reduced inequality might have been less than previously thought.

“I’m from Argentina; inflation is always on my mind because inflation in my country has been high, on and off, for over four decades now,” says Carola Frydman, a professor of finance at Kellogg (and a mentee of Goldin’s in graduate school). “In the U.S., it’s been something we’ve thought about much less.”

In a new paper, Frydman and coauthor Raven Molloy, deputy associate director at the Federal Reserve Board of Governors (and another of Goldin’s mentees), performed a kind of stress test on Goldin and Margo’s key “Great Compression” finding. To do this, the researchers combined detailed data on socioeconomic groups’ expenditures and on price changes between 1940 and 1950.

Frydman and Molloy discovered that, in fact, any socioeconomic group differences in inflation during the 1940s were vanishingly small—only about one-twentieth of the average inflation rate of that period. In other words, the “Great Compression” was just as real—and as dramatic—as Goldin and Margo’s work had suggested.

“At a time when inflation is again relatively high, and debates on who will pay its costs have resurfaced,” the researchers write, “it becomes ever more important to learn from past experience.”

Price checks

In the late summer of 2022, as post-Covid-19 inflation neared its peak, Federal Reserve Chair Jerome Powell noted in a speech about inflation-fighting monetary policy that “the burdens of high inflation fall heaviest on those who are least able to bear them.”

Indeed, research analyzing data since the 1980s has indicated that different income groups do experience inflation differently. For example, during the Great Recession that followed the 2008 financial crisis, inflation rose more significantly for people in the lowest income groups than it did for those in the highest.

But Frydman and Molloy wanted to know if this was also the case in the 1940s, a period when inflation was at one of its highest documented levels in American history.

Unsurprisingly, however, data on 1940s consumer expenditures and on the prices of various goods and services is not nearly as detailed or readily available as is comparable modern data.

So to begin their analysis, Frydman and Molloy first turned to the 1935–36 Consumer Expenditure Survey for information about how consumers at the time spent their money, with data grouped by respondents’ education, occupation, and income. The researchers would have preferred to analyze similar expenditure data from the 1940s, but no similarly detailed data is available. Helpfully, they were able to demonstrate that the spending behavior they observe in the 1935–36 survey falls broadly in line with other, less-detailed surveys conducted in 1941 and 1950.

A few interesting patterns emerge from the expenditure data. When households are grouped by the education level of the husband, for example, families with a less-educated husband spent more of their budget on food—not surprisingly, since lower-income families tend to spend a larger fraction of their budgets on necessities. The families with more education, on the other hand, spend more of their budgets on automobile purchases, household operation, and reading and recreation.

Next, the researchers calculated group-specific inflation rates—and to do that, they needed to collect price data for a wide range of product and service categories. Frydman and Molloy combed through historical Bureau of Labor Statistics reports to construct inflation estimates for 89 specific item categories.

After combining this data to calculate inflation levels across groups, Frydman admits she was surprised by the results.

“I was expecting to find some inflation effects across income groups,” she says, “in part because the 40s were a period of a rapid rise in inflation.”

But the differences were almost nonexistent. And in fact, in contrast to what the modern data reveals, the researchers found that inflation was actually 0.27 percentage points higher for the top quintile of families by income than for the bottom quintile, largely due to the high inflation on domestic services and food away from home. In other words, if anything, the inflation burden fell harder on wealthy families.

“What we find in data from the 1930s and ‘40s is a little bit at odds with what people have found in the post-1980s and 2000s, in terms of which groups suffer more because of inflation,” Frydman says.

Isolating the point of change

Why is this? While it is hard to tell, there are several possibilities.

It’s possible that the 1940s were somewhat unique because of the war effort, Frydman says. Consumers faced a narrower range of choice among goods, for one thing.

But also, spending differences across categories were generally very small in the 1940s, even for items for which Frydman expected to see larger differences across groups, such as movie admissions, beauty-salon services, or cigars. This was even the case for some categories that account for a substantial fraction of most households’ spending, such as shelter. “Whereas the differences in expenditure shares on shelter were quite small by income groups in the 1940s, they have been fairly substantial in recent decades.”

“We don’t yet know whether the patterns we uncovered are unique to the 1940s because of the war, or whether prices increased faster for higher income groups more broadly in the early 20th century,” Frydman explains. It may depend on when spending differences across groups began to widen. “At some point, the pattern changes. What is that point? We’re now working on digging a little deeper into periods outside of the ’40s to try to figure that out.”

Narrowing down that point in time could represent one small step toward understanding what drives the starker income-group differences in inflation experiences that we see today—and how to reverse them.

What we do know, however, is that the Great Compression can’t be explained away by a more detailed understanding of inflation in the period. As the researchers put it, “The Great Compression was ‘real’ after all.”