Inflation Drives Wages Down, Not Up

Judge Glock

Issue Areas

The ‘wage-price spiral’ is a myth. It’s much easier to raise prices than wages.

The Labor Department released a report Friday showing that worker pay increased about 4% in one year, the fastest rate in two decades. This led to predictable alarm that the U.S. is facing a “wage-price spiral,” in which higher wages push up prices, which lead to demands for still-higher wages, and so forth. But the wage-price spiral is a false and antiquated economic idea that refuses to die and keeps generating bad policies.

Wages don’t spiral up during inflation; they spiral down as higher prices eat away paychecks. The dollar amounts on paychecks will rise, but not fast enough for their real value to outpace inflation. The recent stories of wage increases came not long after the government announced prices increased 7% in the past year. A more accurate headline for coverage of Labor’s report last Friday would have been “Real Wages Drop 3%.”

The reason real wages are dropping is simple. Wages are what economists call “sticky,” meaning they don’t change as fast as other prices do. When inflation comes along, gasoline stations can switch their price signs in an hour and restaurants can adjust their menus in a day, but most employees get a salary bump only once a year. Some unions renegotiate their salaries only every five years.

The combination of flexible prices and sticky wages also explains why inflation provides a temporary boost for business. John Maynard Keynes observed that inflation tends to increase profits because it creates a greater spread between the prices businesses charged and the wages they paid. As one International Monetary Fund report stated, during an inflation there is a “redistribution of income away from labor” to capital. This explains recent surging business profits.

Read the full commentary in the Wall Street Journal.