Understanding “wage price” spiral

Inflation is on the headlines, day in and day out. It is giving the government, industry and the common man sleepless nights. RBI has raised interest rates 18 times in a row

It is also being said that inflation is now getting deep seated. What does this mean? Let’s understand.

Inflation is of two types. 1) Supply led inflation and 2) Demand led inflation.

Simplistically put for taming “Supply” led inflation the solution is to increase the supply of goods in the system while for “Demand” led inflation the solution is in “raising interest rates”.

While increasing production would require a higher lead time, increasing interest rates can be implemented relatively faster.

However we have seen now that despite of several rate hikes, inflation doesn’t seem to come down satisfactorily.

So what does one do?

Due to inflationary expectations where people start to panic. This leads them to demand higher wages. Under such pressure organizations tend to increase wages. However more money in the hands of people only adds to inflation causing prices to rise further. Thus inflationary expectations continues unabated causing further panic and demands for wage hikes leading into a self perpetuating cycle of wage hikes and inflation and so on.

This self perpetuating cycle of rising inflation followed by rising wages and then again rising inflation and so on is known as the Wage Price Spiral.

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