Inflation lowers wages, not raises them


The Department of Labor has issued a report Friday showing workers’ pay has risen about 4% in one year, the fastest rate in two decades. This has led to the predictable alarm that the United States faces a “wage and price spiral”, in which higher wages drive up prices, leading to demands for even higher wages, and and so on. But the wage-price spiral is a fallacious and archaic economic idea that refuses to die and continues to generate bad policies.

Wages do not skyrocket during inflation; they are collapsing as higher prices eat away at paychecks. Dollar amounts on paychecks will increase, but not fast enough for their real value to outpace inflation. The recent pay rise stories came shortly after the government announced that prices had risen by 7% in the past year. A more accurate title for the cover of the Labor Party report last Friday would have been “Real Wages Fall 3%”.

The reason real wages are falling is simple. Wages are what economists call “sticky,” meaning they don’t change as fast as other prices. When inflation hits, gas stations can change their price signs in an hour and restaurants can adjust their menus in a day, but most employees only get a pay raise once a year. Some unions only renegotiate their wages every five years.

The combination of flexible prices and rigid wages also explains why inflation gives companies a temporary boost. John Maynard Keynes observed that inflation tends to increase profits because it creates a greater gap between the prices firms charge and the wages they pay. As stated in a report by the International Monetary Fund declared, during inflation there is a “redistribution of income away from labour” towards capital. This explains the recent surge in corporate profits.

We also saw this story unfold in the 1970s, when the idea of ​​the wage-price spiral first gained attention. At the time, many Keynesian economists wanted to blame inflation on something other than the Federal Reserve printing too much money. So they invented the wage-price spiral, also known as cost inflation, which they claimed drove prices up. But they confused nominal wages with real wages. Even though paychecks were worth more dollars, their real value fell nearly 20% over the decade as real profits rose.

As Fed Chairman from 1970 to 1978, Arthur Burns also did not want to take responsibility for inflation. He blamed greedy workers and corporations and thus convinced President Richard Nixon to impose wage and price controls in 1971. This led to shortages throughout the economy and did nothing to stem the ‘inflation. It was only after the Fed adopted the ideas of former Burns student Milton Friedman and began controlling the money supply that inflation came down.

This misconception of wage-price spirals can also have devastating effects in times of recession. When prices fell and the economy collapsed during the Great Depression, some economists argued that low wages held back consumption. They demanded that the government impose wage increases to help drive up purchases and prices, believing this would further drive up wages. Although not named as such, they wanted to start an upward wage-price spiral.

At that time, too, economists confused dollar wages with real wages. Economic research has shown that since prices fell in the first three years of the Great Depression, wage stickiness meant workers’ real wages rose by almost 11%. These high wages have slashed corporate profits, inhibited hiring, and driven unemployment to nearly 25%. Even after the economy began to improve, however, President Franklin D. Roosevelt took the advice of these economists concerned about low wages and signed legislation to raise them through forced unionization and cartels in June. 1933. This boosted unemployment and hampered recovery.

Then as now, activists refuse to recognize the trade-offs between temporarily reviving the economy and raising real wages. For example, the “Fed up” campaign lobbies for more money printing and claims to be “fighting for full employment, rising wages, and a Federal Reserve that works for workers.” Yet the Fed creates a (temporary) boom by allowing workers’ wages to fall and companies to hire more people at low prices. Conversely, if the Fed wanted to raise real wages, it would create deflation, and then wage stickiness would drive up unemployment.

The only way to have a prosperous economy for working people is to maintain a stable monetary policy, which means keeping the amount of money the government prints in line with the needs of the economy. Only the Fed can do that. If we start blaming inflation on other problems, like greedy workers or monopolistic corporations, we will chase away all but the real solution. When workers cash their depreciated paycheck next Friday, it won’t be their fault they’re behind. It will be the Fed’s.

Mr. Glock is director of policy and research at the Cicero Institute and author of “The Dead Pledge: The Origins of the Mortgage Market and Federal Bailouts, 1913-1939.”

Copyright ©2022 Dow Jones & Company, Inc. All rights reserved. 87990cbe856818d5eddac44c7b1cdeb8


Comments are closed.