Wage price spirals aren’t real---unless the whole economy starts spending, small wage hikes don’t generate price rises

The idea that wage‐​price spirals cause inflation – that higher prices lead to higher wage demands, which beget further higher prices and then higher wages again and again – is a long‐​standing myth, and a dangerous one given it can lead to such misguided policy.

There may be good economic reasons for real pay restraint for rail workers, given technological developments and the collapse in rail demand following the pandemic. Rising inflation is not one of them.

Economically, showing that wage demands do not create inflation is fairly simple. Take a hypothetical company with a big, unionised workforce. Suddenly the union demands a competition‐​busting 20 percent pay rise, and the firm reluctantly acquiesces, raising its prices to compensate.

For a given level of total money expenditure in the economy (what we might dub “aggregate demand”), the business’s higher relative price loses some custom. As the business cuts back on production in lieu of higher prices, workers are laid off.

Yet this increases the pool of labour available to other firms, reducing wages elsewhere. Lowering costs of production, this greater worker availability ultimately feeds through into lower prices for other businesses.

In other words, without an increase in economy‐​wide spending, workers in one firm demanding wage hikes don’t generate price rises across the board. Inflation cannot originate from certain trade unions or greedy workers at particular companies.