Wage-Price Dynamics: Are They Consistent with Cost Push?

F or gauging inflationary pressures, many policymakers and financial market analysts pay close attention to the behavior of wages. It is widely believed that if wage costs rise faster than productivity, the price level may rise as firms pass forward increased wage costs in the form of higher product prices. Hence changes in productivity-adjusted wages1 are believed to be a leading indicator of future inflation. One problem with this popular “cost-push” view of the inflation process is that it does not recognize the influences of Federal Reserve policy and the resulting inflation environment on determining the causal influence of wage growth on inflation. If the Fed follows a non-accommodative monetary policy and keeps inflation low, then firms may not be able to pass along excessive wage gains in the form of higher product prices. In fact, an alternative view is that inflation is a “monetary” phenomenon and is caused by excess aggregate demand. According to this view, the causation runs from inflation to wage growth: firms are able to raise the price of their products because of excess aggregate demand caused by an expansionary monetary policy. The resulting increase in prices leads workers to demand higher wages. In this article, I investigate whether wage-price dynamics are consistent with the cost-push view of the inflation process. The cost-push view implies that Fed policy and the resulting inflation environment do not matter in determining the ability of firms to pass forward higher wage costs in the form of higher product prices. Higher wage growth should lead to higher future