Wage-push inflation is an economic theory that states inflation occurs due to wages increasing. The theory claims that these higher wages will cause businesses to raise the price of their final goods, which can cause inflation.
Let’s take a closer look at what the economic theory of wage-push inflation is and how it works.
- Wage-push inflation is an economic theory that states rising wages cause inflation.
- This type of inflation can occur due to union negotiations and new industries.
- There is little empirical evidence to support wages as the predominant cause of inflation.
Definition and Examples of Wage-Push Inflation
Wage-push inflation is the general increase in prices caused by wages rising in society. If wages rise, corporations typically raise the price of their final goods and services. As many goods become more expensive, the overall price level rises and there is inflation. As overall price levels rise, workers realize that their wages do not buy as many goods and services as they did before. Workers ask for raises, which creates a wage-price spiral.
Wage-push inflation is one example of cost-push inflation. Cost-push inflation occurs when supply falls due to increases in labor, raw materials, or capital goods, resulting in inflation.
How Does Wage-Push Inflation Work?
Wage-push inflation can occur for a few reasons, in theory. One is due to unions negotiating set wage increases at fixed intervals for their members. When unions negotiate higher wages for their members, this can push up the cost of the final goods at retailers, which could cause inflation.
Another cause of wage-push inflation is a new industry that may increase wages significantly to attract talent. If other businesses raise wages to compete with the new industry, this can push up wages for many jobs. As a result, firms may increase the price of their final goods sold to consumers, which would then raise the price level. Since the price level increased due to wages rising, this may be considered to be wage-push inflation.
The wage-push theory for inflation started in the late 1960s to early 1970s, as there was an acceleration of wages and prices in Europe while monetary growth slowed. Due to rising wages and increased demand for goods and services, price levels rose.
Is Inflation Caused by Wage Increases Common?
Since wage-push inflation’s birth, research has debunked its theoretical role as a cause of inflation. Instead of higher wages leading to higher prices and inflation, higher prices lead to higher wages. In other words, wages do not push up prices—instead, it’s the other way around.
Alternatively, a more commonly accepted hypothesis, which is supported using data, states that inflation is caused by excessive monetary growth. This is a well-known economic theory called the quantity theory of money.
Alternatives to Wage-Push Inflation
While wage-push inflation doesn’t have much evidence to back it up, there are several types of inflation theories that are accepted as legitimate explanations for why inflation occurs.
One main inflation theory is that central banks cause inflation by increasing money supply, which pushes down interest rates. This makes it easier for businesses and consumers to borrow money to purchase goods and services. As more businesses and consumers buy goods, aggregate demand for goods and services will increase. Since there will be more people competing for limited goods and services, prices rise and inflation follows.
Another cause of inflation is a supply shock. A disruption in supply, such as a natural disaster or high raw material prices, can reduce overall supply temporarily and lead to inflation.
Lastly, expectations play a role in inflation. If people and firms anticipate higher prices, they will negotiate for higher wages or have automatic price increases built into contracts.
It’s not required for all of these theories to occur simultaneously for there to be inflation. However, sometimes a combination of all three causes does happen.
For example, in November 2021, there was 6.8% inflation year-over-year. This was due to a combination of increased aggregate demand from economic stimulus packages and expansionary monetary policy of the Federal Reserve, supply chain shocks, and higher consumer inflation expectations.
A similar situation occurred in the late 1960s and early 1970s when there was monetary growth, an oil energy crisis (which hurt supply), and higher consumer inflation expectations.