Wage-Price Spiral
Candlefocus EditorNormally, wages and prices tend to increase due to normal inflation or economic growth. However, when wages grow faster than the rate of prices, it can lead to a wage-price spiral. This is because, at some point, rising wages lead to higher costs of production, which are passed down to consumers in the form of higher prices. As prices increase, so do wages, leading to higher prices and continuing the cycle. The wage-price spiral continues until it is curbed through some kind of intervention.
Central banks, who are the primary macro-economic policymakers, use a number of monetary policy tools to fight the wage-price spiral. The main tool they use is the setting of a target interest rate. When the central bank sets a higher interest rate, it is more expensive for companies to borrow money, which suppresses wage and price increases. The central bank can also control the money supply by changing reserve requirements, meaning the amount of money a bank must keep on reserve to lend out to customers. The central bank can also directly influence the supply of money in the economy by buying and selling financial assets through open market operations.
Another type of monetary policy used to combat the wage-price spiral is inflation targeting. This monetary policy sets certain parameters for an economy. It sets a target inflation rate and makes sure the economy operates at inflation levels within that target. This prevents prices and wages from spiraling out of control, while also allowing economic growth.
In conclusion, the wage-price spiral is a dangerous cycle of rising wages and prices. Central banks combat this by using various monetary and inflation targeting policies, in order to suppress price increases and take control of economies during periods of wage-price spiral. Of course, this doesn’t guarantee that the cycle won’t start up again. That’s why it’s important to pay attention to wages, prices, inflation levels and economic trends to stay ahead of the wage-price spiral.