## Wage-Price Spiral Risks Appear Contained Despite High Inflation

_IMF Blog, October 5, 2022_

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## Bibliographic details
- Authors: John Bluedorn
- Published: October 5, 2022

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### Key findings on recent wage and inflation dynamics
- Inflation in some economies is rising at the fastest pace in four decades.
- Analysis suggests a sustained acceleration of wages and prices (a wage-price spiral) is unlikely on average.
- Three factors are working together to contain risks:
  - the underlying shocks to inflation are coming from outside the labor market,
  - falling real wages are helping to reduce price pressures,
  - central banks are aggressively tightening monetary policy.

### Historical evidence and episode analysis
- Identified 22 situations in advanced economies over the past 50 years with conditions similar to 2021: price inflation rising, wage growth positive, but real wages and the unemployment rate flat or falling.
- On average, these episodes did not lead to wage-price spirals; instead:
  - inflation came down in subsequent quarters,
  - nominal wages gradually rose, helping real wages recover.
- Heterogeneity across episodes exists; for example:
  - in the United States after 1979, inflation kept rising and real wages fell for a while following further oil price hikes,
  - the inflation trajectory changed only when the Federal Reserve raised interest rates sharply.

### Role of expectations in wage-price dynamics
- Inflation expectations became more important in explaining wage dynamics over the second half of 2021, according to an empirical analysis.
- Model-based analysis calibrated to reflect economic conditions in the first half of this year and taking the policy rate path as given finds differing outcomes depending on expectation formation:
  - Fully adaptive (expect future inflation to equal today’s): can lead inflation to rise and stay above the central bank’s inflation target for a prolonged period even without additional price shocks.
  - Rational (expectations reflect all available information): treats shocks as temporary, leading wage growth and inflation to quickly move back towards target and stay anchored.
  - Adaptive learning (reality between extremes; recent quarters weighed more heavily): wage growth and inflation take longer to return to target than under rational expectations, but faster than under fully adaptive expectations.
- In all expectation scenarios, real wages tend to fall initially as inflation outstrips wage growth, which helps offset some of the cost-push shock and works against a wage-price spiral.
- A labor-market-originating inflationary shock (for example, an unexpected, sharp uptick in wage indexation) could moderate the effects of falling real wages and push up both wage growth and inflation for longer.

### Policy implications and central bank actions
- For monetary policymakers, understanding the expectations process is critical:
  - When expectations are more backward-looking, monetary policy tightening—including through clear communications by the central bank—should be stronger and more front-loaded in response to an inflation shock.
- Recent tightening actions by many central banks—calibrated to economy-specific circumstances—are encouraging and will help to:
  - prevent high inflation from becoming entrenched,
  - prevent inflation from deviating from target for too long.

*This blog is based on Chapter 2 of the October 2022 World Economic Outlook, “Wage Dynamics Post-COVID-19 and Wage-Price Spiral Risks.”*

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## References

- [World Economic Outlook](https://www.imf.org/en/Publications/WEO/Issues/2022/10/11/world-economic-outlook-october-2022)

_Source: https://www.imf.org/en/blogs/articles/2022/10/05/wage-price-spiral-risks-appear-contained-despite-high-inflation_