California has seen significant improvement in employment and wages in the past year. Employment has recovered to pre-pandemic levels in most sectors, and wages have risen steadily since the beginning of 2020 amid a historically tight labor market. And yet more Californians report feeling worse off financially (39%) than better off (17%) compared to a year ago, according to PPIC’s October survey. The share feeling worse off is higher than at any point since 2009. Despite robust employment, income, and wage growth, there’s an obvious culprit harming financial well-being: inflation.

Wages are up across all sectors since January 2020. As of September, wages have increased 14% on average, with gains stronger in leisure and hospitality (24%); trade, transportation, and utilities (16%); and education and health services (13%; not shown in chart).

However, higher earnings don’t go as far in a world of rising prices. After adjusting for inflation, average wages are down 1.3% compared to January 2020. Only two of the largest sectors have shown growth in inflation-adjusted wages: leisure and hospitality (up 7%), and trade, transportation, and utilities (up 1%). Put another way, the average worker is earning $4.50 more per hour today, but with inflation it feels like a $0.50 loss compared to January 2020.

Prices have increased across all major areas of consumer spending, with energy seeing the largest price jumps. As of September, overall energy prices in the Pacific region are up 43% from September 2019, while gas prices are up 49%. Price increases for food have also been above average (up 21%). Price hikes in energy have been stark since September 2020; in the year prior to that, energy and gas prices had actually declined. Lower-income families feel these price increases more severely because a larger share of their budgets go to these essentials.

What is driving these price increases, and what are the prospects for reversing them? Research suggests that the rise in prices through 2022 remains attributable to pandemic factors. These stem from both supply-side issues (e.g., the challenge of producing and delivering goods via the usual supply chains during COVID) and demand-side issues (e.g., the pandemic increase in demand for goods that still persists to a large degree). Wage growth is also a key factor. A historically tight labor market has given workers more bargaining power, and in turn, puts upward pressure on prices. Notably, average wage growth has slowed somewhat in recent months, which may assuage concerns about a feedback loop between wages and inflation, often referred to as a “wage-price spiral.”

Government efforts can ease some supply-side factors through investments in logistics, infrastructure, and the workforce. But these investments take time and would do little to affect inflation in the near and medium term. On the demand side, the US Federal Reserve increased interest rates this week – the sixth time this year – and has signaled its resolve to continue interest rate hikes and has taken other actions that constrict the economy, in an effort to reduce inflation.

Unfortunately, these actions raise the specter of an economic downturn. Raising interest rates and constricting the economy generally lead to an increase in unemployment. This is one major reason recessions can often follow on the heels of inflation; achieving a “soft landing” is difficult. The most generous assessments suggest that in half of previous inflationary episodes the Federal Reserve managed to tame inflation without an ensuing recession. Rising interest rates have already had a marked effect on the housing market; average 30-year mortgage rates are now above 7% for the first time in two decades, reducing affordability and demand.

What can state policymakers do? Although the Federal Reserve’s actions, global supply chain issues, the war in Ukraine, and geopolitical tensions are well outside the purview of state policy, the state still has some tools at its disposal. Efforts to shore up household finances—particularly for the lowest-income families most exposed to rising prices—can alleviate some of the pressures. Indeed, due in large part to federal and state aid, poverty rates fell dramatically across the state and among demographic groups in 2021. Efforts to address energy prices could also help improve household finances. And, with a possible recession looming, furthering policies that can act automatically to stabilize families during a downturn should be a high priority. If a recession does come, state policymakers should be prepared to combat any uneven impacts; in most recessions, low-income, Black, and Latino workers fare worse.