Does wage growth cause price inflation?

February 20th, 2008

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Today, we saw this newspaper article,

The threat of interest rate rises and calls for wage freezes to curb inflation are falling on deaf ears, with almost half of Australians still wanting a pay rise.

A CareerOne survey found 47 per cent of Australians say they are not paid enough. About 25 per cent of workers think about changing their job every day.

It comes as Prime Minister Kevin Rudd this week called for wage restraint, particularly among executives, to reduce spending. He froze politicians’ wages for 12 months, wanting the Government to lead by example.

First, why are Australians getting to restless about their jobs and discontent with their wage? Is it because of greed? No, we believe the more likely reason is debt (see Aussie household debt not as bad as it seems?). With interest rates rise, mortgage rates rise, rising price inflation, rising food and petrol prices, under-performing stock market, there is little wonder that the debt servicing burdens of Australians are rising. With rising debt servicing burdens, there is little wonder that a rise in pay-cheques will be highly appreciated by debtors.

But is the increase in wages the cause for price inflation?

To answer this question, we will look at this book, What You Should Know About Inflation by Henry Hazlit:

The same chain of causation applies to all the so-called “inflationary pressures”?particularly the so-called “wage price spiral.” If it were not preceded, accompanied, or quickly followed by an increase in the supply of money, an increase in wages above the “equilibrium level” would not cause inflation; it would merely cause unemployment. And an increase in prices without an increase of cash in people’s pockets would merely cause a falling off in sales. Wage and price rises, in brief, are usually a consequence of inflation. They can cause it only to the extent that they force an increase in the money supply.

As we said before in Cause of inflation: Shanghai bubble case study, the expansion of money and credit is inflation- not rising prices, wages, petrol, food, etc. For more information about inflation, you can read our guide at What is inflation and deflation?.

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