What Is Wage Push Inflation?
Wage push inflation is an overall rise in the cost of goods and services that results from a rise in wages. To maintain corporate profits after an increase in wages, employers must increase the prices they charge for the goods and services they provide. The overall increased cost of goods and services has a circular effect on the wage increase; eventually, as goods and services in the market overall increase, higher wages will be needed to compensate for the increased prices of consumer goods.
- Wage push inflation is an overall rise in the cost of goods that results from a rise in wages.
- Employers must increase the prices they charge for the goods and services they provide after an increase in wages in order to maintain profits.
- The increase in wages and the resulting increase in prices create a circular effect on wages as higher wages will be needed to compensate for the increased prices of goods and services.
Understanding Wage Push Inflation
Companies can increase wages for a number of reasons. The most common reason for raising wages is an increase in the minimum wage. The federal and state governments have the power to increase the minimum wage.
Consumer goods companies are also known for making incremental wage increases for their workers. These minimum wage increases are a leading factor for wage push inflation. In consumer goods companies especially, wage push inflation is highly prevalent, and its effect is a function of the percentage increase in wages.
Industry factors also play a part in driving wage increases. If a specific industry is growing rapidly, companies might raise wages to attract talent or provide higher compensation for their workers as an incentive to help business growth. All such factors have a wage push inflation effect on the goods and services the company provides.
Economists track wages closely because of their wage push inflation effects. Wage push inflation has an inflationary spiral effect that occurs when wages are increased and businesses must—to pay the higher wages—charge more for their products and/or services. Additionally, any wage increase that occurs will increase the money supply of consumers.
With a higher money supply, consumers have more spending power, so the demand for goods increases. An increase in demand for goods then increases the price of goods in the broader market. Companies charge more for their goods to pay higher wages, and the higher wages also increase the price of goods in the broader market.
As the cost of goods and services rises at the companies paying higher wages and in the broader market overall, the wage increase is not as helpful to employees, since the cost of goods in the market has also risen. If prices remain increased, workers eventually require another wage increase to compensate for the cost of living increase. The percentage increase of the wages and prices and their overall effect on the market are key factors driving inflation in the economy.
Example of Wage Push Inflation
If a state raises the minimum wage from $5 to $20, then a company must pay its employees $20; however, now its cost of producing its goods and services has gone up because its cost of labor is now more expensive. To compensate for the increase in costs, the company must increase the prices of its products on the market. But because the goods and services become more expensive, the initial $15 raise in wages isn't enough to propel a consumer's purchasing power, and the wage must be raised again, therefore causing an inflationary spiral.
Why Do Wage Increases Cause Inflation?
Wage increases cause inflation because the cost of producing goods and services goes up as companies pay their employees more. To make up for the increase in cost, companies must charge more for their goods and services to maintain the same level of profitability. The increase in the prices of goods and services is in inflation.
What Is an Inflation Target?
Governments typically set an inflation target, which in the U.S. is approximately 2% a year. An inflation target allows businesses and individuals to budget for the future. It provides an indicator for companies on how much to pay their employees and how much to charge for their goods and services. It indicates to individuals how much they can expect in wages as well as how much goods and services will cost.
How Does Inflation Impact the Value of Money?
Inflation reduces the value of current money in the future. Because prices go up, the value of a dollar today is worth less than it is in the future. The same dollar today will be able to buy fewer goods and services in the future. Money is always worth more now than it is in the future, particularly due to the investment capability of money.