Price/wage spiral

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In macroeconomics, the price/wage spiral (also called the wage/price spiral) represents a vicious circle process in which different sides of the wage bargain try to keep up with inflation to protect real incomes. This process in turn is one cause of inflation. It can start either due to high aggregate demand or due to supply shocks, such as an oil price hike. There are two separate elements of this spiral that coexist and interact:

• Business owners raise prices to protect profit margins from rising costs, including nominal wage costs, and to keep the real value of profit margins from falling.

• Wage-earners try to push their nominal after-tax wages upward to catch up with rising prices, to prevent real wages from falling. To maintain purchasing power equal to the rising costs reflected by CPI's basket of goods and services, a taxable salary must increase faster than CPI itself to result in an after-tax wage increase comparable to the increased cost of goods and services - unless tax brackets are indexed.

So "wages chase prices and prices chase wages," persisting even in the face of a (mild) recession. This price/wage spiral interacts with inflationary expectations to produce long-lived inflationary process. Some argue that incomes policies or a severe recession is needed to stop the spiral.

The first element of the price/wage spiral does not apply if markets are relatively competitive, while the second does not apply if workers lack labor unions or other sources of bargaining power. Thus, in the neoliberal era of the late 20th and early 21st centuries, when markets have become more competitive and unions have faded, the role of the price/wage spiral has shrunk.

The spiral is also weakened if labor productivity rises at a quick rate. Rising labor productivity (the amount workers produce per hour) compensates employers for higher wages costs while allowing employees to receive rising real wages, while allowing the company's margin to stay the same.

New concerns about wage/price spiral have surfaced with proposals from Presidential candidates and their plans to tie the minimum wage to inflation. The argument is that forced labor costs will create inflation as companies pass on the higher cost of goods sold, thus increasing inflation. Because they would be indexed to inflation, wages will go even higher, continuing the spiral.