Wage-Price Spiral: What It Is and How It’s Controlled

Caroline Banton

Caroline Banton has 6+ years of experience as a writer of business and finance articles. She also writes biographies for Story Terrace.

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Updated April 23, 2025

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Robert C. Kelly

Reviewed byRobert C. Kelly

Robert Kelly is managing director of XTS Energy LLC, and has more than three decades of experience as a business executive. He is a professor of economics and has raised more than $4.5 billion in investment capital.

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Part of the Series

Inflation

Inflation: What It Is and How to Control Inflation Rates

Understanding Inflation

Types of Inflation

What Does Inflation Impact?

Understanding Hyperinflation

Understanding CPI

Related Terms (A-I)

Related Terms (J-Z)

Wage-Price Spiral: A macroeconomic theory explaining the cause-and-effect relationship between rising wages and prices. — Investopedia / Julie Bang

Definition

The wage-price spiral describes the cyclical relationship between rising wages that lead to greater consumer demand and consumer demand that drives up prices and prompts more wage hikes.

What Is the Wage-Price Spiral?

The wage-price spiral is a macroeconomic theory that explains the cause-and-effect relationship between rising wages and prices, or inflation. That is, as rising wages increase disposable income, demand for goods rises, triggering prices for goods to move higher.

Rising prices then increase demand for higher wages, which leads to higher production costs and further upward pressure on prices, creating a conceptual spiral.

Key Takeaways

The wage-price spiral describes a perpetual cycle whereby rising wages create rising prices, and vice versa.
Central banks use monetary policy, interest rates, reserve requirements, and open market operations to curb the wage-price spiral.
Inflation targeting is a monetary policy used to achieve and sustain a specific interest rate.

Inflation

The wage-price spiral describes the phenomenon of price increases as a result of higher wages. When workers receive a wage hike, they demand more goods and services, and this, in turn, causes prices to rise.

The wage increase effectively increases generalbusiness expenses that are passed on to the consumer as higher prices. A perpetual loop or cycle of consistent price increases is created.

The wage-price spiral reflects the causes and consequences of inflation, and it is, therefore, characteristic of Keynesian economic theory.

Fast Fact

The wage-price spiral is also known as thecost-push origin of inflation.

How a Spiral Begins

A wage-price spiral is caused by the effect of supply and demand on aggregate prices. People who earn more than thecost of living decide upon an allocation of savings and consumer spending. As wages increase, so does a consumer's propensity to both save and consume.

For example, if the minimum wage increases, many consumers within the economy will purchase more products, which would increase demand. The rise inaggregate demand and the increased wage burden cause businesses to increase the prices of products and services.

Although wages may be higher, these higher prices cause workers to demand higher salaries again. If higher wages are granted, a spiral where prices increase may occur. This cycle can repeat until higher wage levels can no longer be supported.

Important

In January 2025, 21 states increased their minimum wage. Of these, those states with hourly rates that match or exceed $15 per hour are Rhode Island, Connecticut, Delaware, New Jersey, New York, Illinois, California, and Washington.

Stopping a Wage-Price Spiral

A wage-price spiral often pushes inflation to a level that is not ideal. The U.S. Federal Reserve aims to sustain an inflation rate of 2%, which it deems appropriate to maintain maximum employment and price stability.

Governments tackle an inflationary environment through the actions of acentral bank, such as the Fed. Thus, when U.S. inflation moves higher that 2%, the Fed takes steps to bring it back under control.

Monetary Policy

The Fed can usemonetary policy tools such as administered interest rates, reserve requirements, and open-market operations to curb inflation and the wage-price spiral.

However, this can sometimes trigger arecession. For example, the 1970s were a time of oil price increases by OPEC that resulted in increased domestic inflation.

The Federal Reserve responded by raising interest rates to control inflation. This stopped the spiral in the short term but led to a recession in the early 1980s.

Inflation Targeting

Inflation targeting is a monetary policy strategy whereby the central bank sets a target inflation rate (as mentioned above) for a period of time and makes adjustments to achieve and maintain that rate.

In 2018, Ben S. Bernanke, Thomas Laubach, Frederic S. Mishkin, and Adam S. Posen argued inInflation Targeting: Lessons from the International Experience, the advantages and disadvantages of inflation targeting.

They concluded that governments should use discretion based on the circumstances when deciding to use inflation targeting as a tool to control the economy.

What Is Monetary Policy?

Monetary policy relates to controlling the overall supply of money available to the nation's banks, consumers, and businesses. The Federal Reserve influences the supply in the economy through open market operations (OMO) by buying financial securities when easing monetary policy and selling financial securities when tightening monetary policy. It may choose to increase interest rates on borrowing to discourage spending or force down interest rates to inspire more borrowing and spending.

What Is the Difference Between the U.S. Treasury and the Federal Reserve?

The U.S. Treasury and the Federal Reserve are separate entities. The Fed's mandate is to maintain maximum employment and price stability. The Department of theTreasury manages federal spending. It collects the government's tax revenues, distributes its budget, issues its bonds, bills, and notes, and prints money. The Federal Reserve is the central banking system of the U.S. and is run by a board of governors that oversees 12 regional Federal Reserve Banks.

What Is Inflation Targeting?

Inflation targeting is a monetary policy that seeks to achieve a specified annual inflation rate. The principle of inflation targeting is based on the belief that long-term economic growth is best achieved by maintaining price stability, and price stability is achieved by controlling inflation.

The Bottom Line

The wage-price spiral is a perpetual cycle where rising wages create rising prices and vice versa. The Fed uses monetary policy tools to target resulting inflation and curb the wage-price spiral.

Article Sources

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