Inflation is well and truly back. With prices rising across the economy, years of reckless money-printing has come home to roost. Central banks are (at least talking about) raising interest rates and politicians are busy finding excuses, the most convenient being Vladimir Putin. Many fear that the worst is yet to come. British Prime Minister Boris Johnson has warned about a wage-price spiral, the traditional inflation bogeyman, and the Bank of England has encouraged unions and workers to show restraint in their wage demands. In the US, Fed Chair Jerome Powell ahs warned about the unsustainability of accelerating wage gains. But if, like Austrian economists believe, inflation is monetary phenomenon, the result of too much money chasing too few goods, what do we make of the wage-price spiral, a decidedly non-monetary phenomenon blaming accelerating inflation on workers seeking higher wages to compensate for inflation and by that adding fuel to the inflationary fire, resulting in ever higher prices and wage demands?
One issue with wage-price spiral is that it is deceptively easy to understand: higher prices leads to increased wage demands leading to higher prices leading to… This is known as cost-push inflation, where price rises are driven by increases in the cost of inputs to the production process (and according to Modern Monetary Theory the almost exclusive cause of inflation, as opposed to demand-pull inflation, the traditional Keynesian explanation of inflation when aggregate demand outpaces supply and causes prices to rise). But cost push inflation – whether the increased cost is labour, oil or fertilizer – does not actually describe inflation, a rise in the overall price level driven by an increase in the money supply, but a shift in relative prices due to demand/supply dynamics. A wage increase is exactly that: an increase in the cost of labour relative to other resources. As a result, goods and services relying intensely on labour as production input will rise in price relative to goods which depend less on labour. This is equivalent to how a failed harvest raises the price of corn or how the war in Ukraine leads to higher oil prices. Not inflation, but a rise in some prices relative to others.
Of course, that is not to say that wage-induced price increases are a myth or that the phenomenon is unrelated to inflation. A rise in wages will indeed lead to higher prices on many consumer goods, which could encourage even higher wage demands. But as the price of some goods increases, consumers have the choice between spending more money on those goods or consuming less. Higher spending will leave less money for other goods, which may experience falling prices as demand dries up –affecting relative prices, not the overall price level. Less consumption will lead to less demand for labour, reducing the pressure for higher wages – reversing the relative price increase.
In the end, the price of money, like all other goods and assets, depends on the demand. If the quantity of money doesn’t change and demand for money (credit) doesn’t change, so-called cost-push inflation is simply an appreciation of the price of certain factors of production. Wage-price spirals cannot increase the overall price level. Only a change in the money supply can do that. So politicians and central bankers are wrong to fear them – the damage is done; they are merely a manifestation of the increase in the money supply they themselves are responsible for.