Economic theory of wage-driven inflation explained amid strikes

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Boris Johnson’s government has repeatedly used the theory – also known as the ‘wage and price spiral’ – to fend off calls for pay rises

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However, the government used the economic theory of “wage-push inflation” to argue against supporting wage increases.

So what does this economic theory mean – and do all economists agree with it?

Here’s what you need to know.

Why are salaries making headlines?

Wages are in the headlines because record inflation has meant many workers have taken a pay cut in real terms in recent months.

According to the Office for National Statistics, average wage growth without bonuses was 4.2% in April, less than half the current rate of inflation.

This essentially means that payment packages are not keeping pace with price increases, which reduces consumer purchasing power.

Passengers disembark a train as the biggest rail strike in over 30 years hits the UK (Photo: BEN STANSALL/AFP via Getty Images)

Meanwhile, public sector workers are also reportedly considering a strike as the government has called for wage moderation.

What is wage push inflation?

Also known as the wage-price spiral, this economic theory considers that the increase in workers’ wages acts as the main driver of inflation.

Essentially, the idea is that if you pay people more money to work, you increase the costs for the company that employs them, and therefore the price of the final product.

Wage inflation is an economic theory that has never been proven in the real world (Image: PA)

Since inflation is a measure of how expensive goods and services become over a period of time, the theory states that higher wages will increase inflation.

It also indicates that once workers find that their purchasing power has been eroded by this increased inflation, they will seek larger wage increases and the process will start all over again, driving up inflation even further.

Economic theory emerged in the 1960s and 1970s at a time when inflation was seen by academics as a major threat to the economy.

This thinking grew out of the fact that more workers were working for fewer companies, the largest of which were sometimes state-owned.

Therefore, any widespread calls for wage increases were seen as likely to lead to inflationary pressures.

Rishi Sunak and other members of Boris Johnson’s cabinet have repeatedly called for wage moderation amid inflation fears (Image: PA)

Instead, economists think inflation is largely driven by supply disruptions (like the ones we’ve seen due to Brexit, Covid and the Russian-Ukrainian war) and money lending cheap prices that impede the supply of goods and services.

Does the government use the wage inflation theory?

Some of the language used by the government in the face of the cost of living crisis suggests that it is using the economic theory of wage-push inflation.

He repeatedly called for the moderation of wage demands.

Boris Johnson told MPs earlier in June: “When a wage-price spiral begins, there is only one remedy and that is to curb rising prices with higher interest rates. “

This claim led dozens of economists to write a letter to the PM which said, “Wage suppression is the exact opposite of what is needed in response to this current wave of inflation, and risks fueling a dramatic increase in poverty and hardship, and eventually a recession.

“Inflation today is driven by huge external factors including aftershocks from lockdowns, the war in Ukraine and extreme weather events around the world.

“It is not the product of national wage demands.”

Just a day after the open letter was published, Chief Treasury Secretary Simon Clarke said wage demands that sought to match the rate of inflation risked creating a “runaway” wage and price spiral. 1970s style.

And on Tuesday June 21, Downing Street insisted that ‘chasing inflation’ with pay rises for public sector workers was not ‘doable’ as it would fuel inflation further.

A Number 10 spokesman told reporters: ‘We believe it would not be reasonable and would not be in the interest of these public sector workers to chase inflation, to drive inflation up even further inflation and actually mean that the money they take home is worth less.”

They insisted the government wanted public sector workers to get pay rises and that these would be determined by pay review bodies over the next few months.

The use of the wage-push inflation theory came at a time when Boris Johnson and his Chancellor Rishi Sunak stressed ‘the importance of fiscal discipline’ following major public spending drives during the Covid pandemic.

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