Is the United States Experiencing a Wage-Price Spiral?

Is the United States Experiencing a Wage-Price Spiral?

INSIGHTi

Is the U.S. Experiencing a Wage-Price Spiral?
January 11, 2023
Recent high inflation and nominal wage growth has sparked a debate about whether the United States is
currently in a wage-price spiral. A wage-price spiral is said to occur when expectations of inflation
become embedded in decisionmaking on the part of workers, who demand higher wages to compensate
themselves for perceived future price increases in a way that creates more inflation, creating a cycle that
results in persistently increasing inflation. A consensus definition of wage-price spiral does not exist
among economists, and, to some extent, debate about whether or not the United States may be
experiencing one would depend upon the definition used. For the purposes of this CRS Insight, a wage-
price spiral can be ruled out if nominal wage increases do not meet or exceed price increases.
For more information about recent wage trends, see CRS Report R47380, Average Wage Growth and
Related Economic Trends in 2022, by Lida R. Weinstock.
The Connection Between Wages and Inflation
Economists distinguish between nominal wages, which are the actual wages that workers receive at any
given time, and real wages, which are adjusted for inflation so purchasing power can be compared over
time. When negotiating wages, one factor that employers and workers are considering is the prices they
think they will face in the future. If employers think they will be able to get more money for their
products or services in coming months or years, they may be willing to raise wages, all else equal. If
employees think things they buy will cost more in the future, they may request higher wages.
In a wage-price spiral, workers are able to negotiate higher pay in excess of productivity and inflation,
causing the costs of businesses to increase as a result. In response, those businesses increase the prices of
their products in order to cover those increased costs (assuming businesses do not reduce profit margins
instead), causing inflation. Workers see that prices have increased, fulfilling their expectations and
therefore further embedding their belief that prices will continue to increase. Once embedded, this self-
fulfilling prophecy can prove difficult to break.
Is There Evidence of a Wage-Price Spiral?
Current high inflation and nominal wage growth has some spectators worried that the United States could
be on the verge of a wage-price spiral or that, at the very least, rising wages are playing some role in high
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inflation. Figure 1 below shows nominal wage growth and inflation since 2020. While nominal wage
growth has been relatively high during this period, inflation began to outpace wage growth in March
2021, resulting in negative real wage growth. Given the fairly persistent reduction in real wages, it is
unlikely that the United States is currently experiencing a wage-price spiral. Although workers have taken
advantage of a tight labor market to increase their wage demands, the fact that, on average, workers’ real
wages have not increased could indicate several things. It is possible that workers may not have fully
anticipated inflation, but it could also be evidence of frictions in the labor market such as a mismatch in
bargaining power or a lag in the wage response to tight labor market conditions.
Figure 1. Wages and Inflation
January 2020 to November 2022

Source: BLS CES and CPI data.
Even if the United States has not, to this point, experienced a wage-price spiral, it is possible that it will
enter one in the near term. Looking to larger labor market and macroeconomic conditions can help
determine if this is likely. One the one hand, cost-of-living adjustments and other automatic wage
indexation are not as prevalent in the United States as they were in the past, and some literature suggests
that the pass-through of wages to inflation has declined over time. On the other hand, U.S. labor markets
have been fairly tight in recent months (although there are some indications they may be loosening).
Workers typically have more bargaining power in a tight labor market than in a loose one, thus enabling
them to either more quickly renegotiate higher wages or negotiate more significant wage increases than
they would have been able to in a weaker market.
Inflation expectations, which generally determine the level of wage increase workers desire, show mixed
evidence. According to the Federal Reserve’s Survey of Consumer Finance, the median one-year-ahead
expected inflation rate rose significantly in 2021 and remained high in 2021, although it has decreased for
the past couple of months. In contrast, the median three-year-ahead expected inflation rate has remained
relatively anchored throughout 2021 and 2022. A recent Federal Reserve Bank of San Francisco working
paper found the role of inflation expectations in wage changes to have increased over the course of the
pandemic, with a one-to-one relationship between the increase in expected inflation and resultant increase
in wages currently. All told, if expectations do become unambiguously unanchored, a wage-price spiral
would be more likely.

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Regardless of whether the United States enters a wage-price spiral in the near future, nominal wage
growth is likely contributing to high inflation in some part. Without a loosening of labor market
conditions and a deceleration in nominal wage growth, inflation may be unlikely to return to a low and
stable level. Federal Reserve Chair Jerome Powell characterized this idea in recent remarks: “In the labor
market, demand for workers far exceeds the supply of available workers, and nominal wages have been
growing at a pace well above what would be consistent with 2 percent inflation over time. Thus, another
condition we are looking for is the restoration of balance between supply and demand in the labor
market.”

Author Information

Lida R. Weinstock

Analyst Macroeconomic Policy

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