1. Home
  2. Knowledge Base
  3. Wage-Price Spiral – Definition

Wage-Price Spiral – Definition

Wage-price Spiral Definition

The wage-price spiral is theory that indicates the interrelationship between increase in wages and increase in prices of goods, it is otherwise known as inflationary spiral. It is a theory commonly used in the macroeconomic field. This theory represents a circle in which rise in wages and prices mounts pressure on the economy, thereby causing inflation. Increase in wages have some effects such as increasing costs of goods, increasing consumer purchasing power, and increasing demands for commodities.

A Little More on What is Wage-price Spiral and Inflation

The wage-price spiral is a theory in macroeconomics that reflects the consequential relationship between prices and wages as well as inflation, in that a rise in wages has an effect on the prices of goods. Once wages increase, the prices of goods follow suit, they also increase. The cause and effects of inflation are presented by the wage-price spiral.

How a Wage-price Spiral Begins

A wage-price spiral represents the relationship between demand and supply, as well as wages and prices. An inflationary spiral begins when there is an upward movement in price, thereby leading to people demanding a rise in wages. As prices of goods begin to increase, employees mount pressure on employers for increased wages but as soon as wages increase, the costs of goods become higher. Hence, the higher the prices of goods, the more workers ask for a rise in wages. In a wage-price spiral, a rise in wages leads to a rise in costs of goods and vice versa.

Stopping a Wage-price Spiral

There are few ways to stop a wage-price spiral, curbing a wage-price spiral is important to achieve stability in the economy. Government of most economies stop a wage-price spiral through many policies by the central bank or Federal Reserve. Some of the policies are monetary policy, interest rate, open market policy and reserve requirements, and other monetary policies.

Real World Example

Many countries have experience a wage-price spiral at one time or the other. One of the examples was the wage-price spiral that occurred in the United States in 1970, this was when OPEC increased the price of oil as a result of inflation occurring domestically.  This inflation was curbed by the United States government using the monetary policy. When monetary policy is being used to curb inflation, central banks set a limit for inflation rate at that period.

A recent study conducted in 2018 by many authors on ‘Inflation Targeting’ concluded that rather than relying absolutely on monetary policy to stop wage-price spiral, decisions should be made by governments based on the happenings surrounding the inflation.

Here are some important things to note about the wage-price spiral;

  • The wage-price spiral reflects an incessant or persistent cycle where increase in wage cause a rise in price leading to inflation.
  • There are a number of measures adopted by countries to curb the cause and effect relationship of increase in wage and increase in price peculiar in the wage-price spiral.
  • Interest rates and open market policies and other monetary policies are some measures of preventing the effects of the wage-price spiral.

References for “Wage-Price Spiral

Academic research for “Wage-Price Spiral

The wage price spiral, Blanchard, O. J. (1986). The wage price spiral. The Quarterly Journal of Economics, 101(3), 543-565.

Slowing the wage-price spiral: the macroeconomic view, Perry, G. L., Baily, M. N., & Poole, W. (1978). Slowing the wage-price spiral: the macroeconomic view. Brookings Papers on Economic Activity, 1978(2), 259-299.

Unemployment and the open economy wage-price spiral, Kolsrud, D., & Nymoen, R. (1998). Unemployment and the open economy wage-price spiral. Journal of Economic Studies, 25(6), 450-467.

Keynesian dynamics and the wage–price spiral: a baseline disequilibrium model, Asada, T., Chen, P., Chiarella, C., & Flaschel, P. (2006). Keynesian dynamics and the wage–price spiral: a baseline disequilibrium model. Journal of Macroeconomics, 28(1), 90-130.

Unit root in the wage-price spiral is not hysteresis in unemployment, Amable, B., Henry, J., Lordon, F., & Topol, R. (1993). Unit root in the wage-price spiral is not hysteresis in unemployment. Journal of Economic Studies, 20(1/2).

From a var model to a structural model, with an application to the wage–price spiral, Monfort, A., & Rabemananjara, R. (1990). From a var model to a structural model, with an application to the wage–price spiral. Journal of Applied Econometrics, 5(3), 203-227.

Inflationary inertia in a wage-price spiral model, Zeira, J. (1989). Inflationary inertia in a wage-price spiral model. European Economic Review, 33(8), 1665-1683.

Keynesian dynamics and the wage–price spiral: identifying downward rigidities, Chen, P., & Flaschel, P. (2005). Keynesian dynamics and the wage–price spiral: identifying downward rigidities. Computational Economics, 25(1-2), 115-142.

Expectations and the Wage‐Price Spiral in a Simple Monetary Model, Scarth, W. M. (1977). Expectations and the Wage‐Price Spiral in a Simple Monetary Model. The Manchester School, 45(3), 208-220.

Keynesian Dynamics and the Wage-Price Spiral: Analyzing and Estimating a Baseline Disequilibrium Model, Chen, P., Chiarella, C., Flaschel, P., & Semmler, W. (2005). Keynesian Dynamics and the Wage-Price Spiral: Analyzing and Estimating a Baseline Disequilibrium Model. The IUP Journal of Monetary Economics, 3(3), 6-49.

Was this article helpful?