What is the wage-price spiral theory? Why is this important? Why is this a myth?
This economic theory or view says that worker’s future expectations of inflation result in workers demanding higher (or lower) salaries to compensate for the future inflation. As a result, this prompts companies to raise prices and ultimately again, workers demand pay increases. Many say next a vicious cycle ensues and that inflation can spiral out of control. However, not so fast.
This is because of employers. Employers may be willing to increase wages if they think inflation will continue, but that’s not always the case.
The reason that the “Wage-Price Spiral” is a myth has to do with the fact that businesses have other costs besides labor. Increasing labor costs by 10% doesn’t have to lead to an increase in the company’s product prices. There are other factors like input costs. For example, a company might have bought widgets last year at $100, and this year they are $102.
Don’t get me wrong, it’s surely possible that a ‘Death spiral’ could happen, but its’ it’s important to remember it’s not given. Companies usually are slow giving pay raises, and that in of itself would prevent inflation from spiraling out of control.
So, to sum up, the wage-price spiral is a myth and inflation is driven by the money supply.
