Price/wage spiral

In macroeconomics, the price/wage spiral (also called the wage/price spiral or wage-price spiral) is a theoretical concept that represents a circle process in which wage increases cause price increases which in turn cause wage increases, possibly with no answer to which came first. According to the concept, it can start either due to high aggregate demand combined with near full employment[1] or due to supply shocks, such as an oil price hike. There are two separate elements of this spiral that coexist and interact:

  • Business owners raise prices to protect profit margins from rising costs, including nominal wage costs, and to keep the real value of profit margins from falling.
  • Wage-earners try to push their nominal after-tax wages upward to catch up with rising prices, to prevent real wages from falling. To maintain purchasing power equal to the rising costs reflected by a consumer price index (CPI), a taxable salary must increase faster than the CPI itself to result in an after-tax wage increase comparable to the increased cost of goods and services – unless tax brackets are indexed.

According to the concept, "wages chase prices and prices chase wages", persisting even in the face of a (mild) recession. This price/wage spiral interacts with inflationary expectations to produce long-lived inflationary process. Some argue that incomes policies or a severe recession is needed to stop the spiral.

The first element of the price/wage spiral does not apply if markets are relatively competitive.

The spiral is also weakened if labor productivity rises at a quick rate. Rising labor productivity (the amount workers produce per hour) compensates employers for higher wages costs while allowing employees to receive rising real wages, and while allowing the company's margin to stay the same.

References
  1. "Theory 6 – Wage-price spiral – is inflation spiraling out of control?". Biz/ed. Archived from the original on April 8, 2009.
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