Wage-Price Spiral

What is ‘Wage-Price Spiral’

The wage-price spiral is a macroeconomic theory used to explain the cause-and-effect relationship between rising wages and rising prices, or inflation. The wage-price spiral suggests that rising wages increases disposable income, thus raising the demand for goods and causing prices to rise. Rising prices cause demand for higher wages, which leads to higher production costs and further upward pressure on prices, creating a conceptual spiral.

Explaining ‘Wage-Price Spiral’

Wage-price spiral is an economic term that describes how prices increase when wages increase. It’s a phenomenon that occasionally occurs when the general prices for goods and services increase, causing workers to demand a wage hike. The wage increase effectively increases general business expenses that are passed on to the consumer in the form of higher prices. It’s essentially a loop or cycle that perpetuates itself by consistent prices increases.

How a Wage-Price Spiral Begins

A wage-price spiral is a simple matter of the effect of supply and demand on aggregate prices. People who make income above their cost of living usually decide on an allocation mix between savings and consumer spending. As wages increase, so too does a consumer’s propensity to both save and consume.

Stopping a Wage-Price Spiral

Governments and economies like to have stable inflation — or price increases. A wage-price spiral often makes inflation increase higher than is ideal. Governments have the option of stopping this inflationary environment through the actions of the Federal Reserve or central bank. A country’s central bank can use monetary policy, by way of the interest rate, reserve requirements or open market operations, to curb the wage-price spiral.

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