What is wage-push inflation?

Definition and Examples of Wage-Driven Inflation

Wage-driven inflation is an economic theory that states inflation occurs due to rising wages. The theory claims that these higher wages will make companies raise their prices for final goods, which can lead to inflation.

How Does Wage-Driven Inflation Work?

Wage-driven inflation can occur for several reasons, theoretically. One reason is due to unions negotiating wage increases at fixed intervals for their members. When unions negotiate wage increases for their members, the cost of final goods in stores can rise, which may cause inflation.

Another reason for wage-driven inflation is the emergence of a new industry that may significantly increase wages to attract talent. If other companies raise wages to compete with the new industry, wages for many jobs may rise. As a result, companies may increase the prices of their final goods sold to consumers, raising the price level. Since the price level has risen due to wage increases, this can be considered wage-driven inflation.

Is Wage-Driven Inflation Common?

Since the inception of wage-driven inflation, research has denied its theoretical role as a cause of inflation. Instead of higher wages leading to higher prices and inflation, higher prices actually lead to higher wages. In other words, wages do not push prices up; rather, the opposite occurs.

Instead, the more commonly accepted hypothesis, which is supported by data, states that inflation occurs due to excessive monetary growth. This is the well-known quantity theory of money.

Alternatives to Wage-Driven Inflation

Although there is not much evidence supporting wage-driven inflation, there are several types of inflation theories that are accepted as legitimate explanations for why inflation occurs.

Monetary Policy: One of the main theories of inflation is that central banks cause inflation by increasing the money supply, leading to lower interest rates. This makes it easier for businesses and consumers to borrow money to purchase goods and services. With more goods and services being bought by businesses and consumers, aggregate demand for goods and services will increase. As more people compete for limited goods and services, prices rise and inflation occurs.

Supply Shock: Another cause of inflation is supply shock. Disruptions in supply, such as natural disasters or rising raw material prices, can temporarily reduce overall supply and cause inflation.

Consumer Expectations: Finally, expectations play a role in inflation. If people and businesses expect prices to rise, they will negotiate for higher wages or ensure automatic price increases in contracts.

Historical Examples

It is not necessary for all these theories to occur simultaneously for inflation to happen. However, at times, all three causes may be present. For example, in November 2021, there was a 6.8% year-over-year inflation rate. This was due to rising aggregate demand from economic stimulus packages and the Federal Reserve’s expansionary monetary policy, supply chain shocks, and high consumer inflation expectations.

A similar situation occurred in the late 1960s and early 1970s when there was monetary growth, an oil crisis (which affected supply), and high consumer inflation expectations.

Sources:

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Federal Reserve Bank of St. Louis. “Inflation: The Cost-Push Myth,” page 21. Accessed January 6, 2022.

Institute

Brookings. “Global Inflation and Monetary Adjustment in Eight Countries (Robert J. Gordon, Northwestern University),” pages 410-411. Accessed January 6, 2022.

Federal Reserve Bank of St. Louis. “Inflation: The Cost-Push Myth,” page 25. Accessed January 6, 2022.

U.S. Bureau of Labor Statistics. “Consumer Prices Rise 6.8% for the Year Ending November 2021.” Accessed January 6, 2022.

History of the Federal Reserve. “The Great Inflation.” Accessed January 6, 2022.

Source: https://www.thebalancemoney.com/what-is-wage-push-inflation-5214749