As prices rise across the country and across the economy, the fiscal worry word of the day is “inflation.” Early in the year, there was widespread consensus that rising prices were just a temporary trend caused by the end of lockdowns. But by summer, Bloomberg was reporting that large and unexpected springtime wage increases were making it harder to argue that the country’s growing inflation problem would be a passing phase.
The cost of goods and services, after all, is directly connected to the wages earned by the people who make those goods and provide those services.
Inflation and Wages: Where One Goes, the Other Follows
Inflation is the unstoppable economic force that slowly and steadily drains the purchasing power from your dollars by driving the cost of everything up over time. There are three types of inflation:
- Built-in inflation: With this type of inflation, rising prices force employers to raise wages so their workers can maintain their standard of living.
- Demand-pull inflation: When workers earn more, they buy more stuff, which sends demand — and prices — up.
- Cost-push inflation: When production costs rise — from factors like increased labor costs — producers must respond by raising the price of their products.
As you can see, there is no scenario where changes in wages don’t impact the price of goods and services and vice versa.
Wage-Push Inflation: Does Higher Pay Lead To Higher Prices?
Wage-push inflation falls under the umbrella of cost-push inflation, which occurs when producers raise prices to compensate for increased production costs. Those increases could be in the cost of shipping, the cost of raw materials, the cost of energy or the cost of labor.
When that last one is the culprit, it’s called wage-push inflation. When wages rise steadily and consistently over time, those higher earnings don’t trigger sharp inflation. But sudden and dramatic economy-wide wage increases certainly can. That kind of fast nationwide pay raise usually comes from one of two economic drivers — a hike in the minimum wage or a labor crisis.
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The minimum wage has been stagnant for the longest period in American history since the minimum wage was a thing, so that’s not to blame. But — surprise, surprise — the country is being squeezed by a widespread and months-long labor crisis, which has desperate employers rapidly boosting wages all over the economy to compete for a severely limited pool of talent.
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Wage-Push Inflation Is Not Settled Science
An economist writing for the conservative John Locke Foundation recently made a well-reasoned argument that wage-push inflation is a myth that was discredited among thoughtful economists decades ago. Although his logic is too involved for the context of this article, the idea is that higher prices can never be sustained without new money entering the economy, irrespective of what happens with wages.
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Another respected economist wrote in The Real Economy Blog that while wage inflation is not exactly a myth, it is a phenomenon that isn’t nearly as powerful or relevant today as it was between 1965-1985 when manufacturing was the driving engine of the U.S. economy. Other economists argue that wage-push inflation is as real as it ever was.
The controversy was on full display recently when CNBC opined that the silver lining of America’s rising inflation is that wages could rise right along with prices. The article was almost immediately panned on Twitter for suggesting that wages could ever keep pace with runaway inflation. One commenter summed it up with this: “For the next article, how about: ‘Earthquake’s silver lining: more construction jobs.'”
This article is part of GOBankingRates’ ‘Economy Explained’ series to help readers navigate the complexities of our financial system.
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