Economics of Inflation - The Wage-Price-Spiral

In this revision video, we look at the economics of a wage-price-spiral and evaluate how likely one will occur in the UK economy?

What is a wage-price spiral?

A wage price spiral is a situation where workers bid for higher wages because they have seen their real income eroded by fast-rising prices.

This can lead to a further burst of cost-push inflation in an economy.

How can a wage-price spiral develop?

The importance of inflation expectations

A wage-price spiral is more likely when an increase in the actual cost of living leads to people raising their own expectations of inflation. Expectations of the future can drive behaviour today. The Central Bank is concerned to keep inflation expectations under control to help meet their inflation target.

Is there a risk of a wage-price spiral affecting the UK economy?

Upside risks:

• Consumer price inflation in the UK (October 2021) is well above target (3.1%)
• Millions will quickly notice their real incomes taking a hit in 2021-22
• Many industries across the UK are facing severe labour shortages
• Job vacancies are at a record high (well over 1 million)
• Plenty of stories of businesses ramping up wages to attract workers
• Perhaps the balance of power in the labour market is tilting to workers

Evaluation points:

• Firms could absorb higher wages in their profit margins rather than raising prices
• Well over 4 million workers in the public sector have their pay controlled by the government
• Trade union density remains low (less than 25% of people in work)
• Many economists believe the surge in inflation will be transitory and have little effect on people’s inflation expectations
• The Bank of England will likely raise interest rates to control inflationary pressures.