Wage-Price Spirals

Guido Lorenzoni () and Ivan Werning
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Ivan Werning: Massachusetts Institute of Technology

Brookings Papers on Economic Activity, 2023, vol. 54, issue 2 (Fall), 317-393

Abstract: We interpret recent inflation experience through the lens of a New Keynesian model with price and wage rigidities and nonlabor inputs in inelastic supply. The model provides a natural interpretation of some features of the recent episode: an initial surge of noncore inflation, followed by a lagged response of core inflation and a further lagged, persistent response of wage inflation. The model also provides a natural way of discussing the role and the strength of wage-price spiral dynamics in price-setting models. The model interprets recent developments as symptoms of underlying supply constraints, which can be triggered by both demand and supply shocks. The immediate manifestation of these constraints is in the relative price of scarce, inelastic nonlabor inputs (including energy). The secondary effects arise because they produce a gap between lowered real wage aspirations of firms - that try to make up for higher nonlabor costs - and increased real wage aspirations of workers - caused by increased labor demand. The gap produces a wage-price spiral, which continues as long as the initial relative scarcity of nonlabor inputs persists, even though input prices are falling. In this view, the fact that nominal wage growth is currently exceeding price inflation can be given a benign interpretation, as a sign of real wages going back to trend and not necessarily as a concern of an ongoing spiral.

Keywords: Wage-price spirals; inflation; labor economics (search for similar items in EconPapers)
Date: 2023
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