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The Dynamics of a Wage-Price Spiral
An economy, initially experiencing stable inflation, is hit by a one-time 'cost-push' shock where labor unions successfully negotiate significantly higher wages for workers. Analyze the process through which this single event can evolve into a persistent, year-over-year increase in inflation, commonly known as a wage-price spiral. Your analysis must clearly explain the critical role that the expectations of workers and firms play in sustaining this cycle.
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Analyzing Persistent Inflation
Following a significant, economy-wide increase in negotiated labor costs (a cost-push shock), a self-perpetuating inflationary cycle can begin. Arrange the following events to correctly illustrate the sequence of a wage-price spiral.
An economy experiences a one-time supply shock that raises production costs for all firms, leading to an initial increase in the inflation rate. For this single event to trigger a persistent, self-perpetuating wage-price spiral, which of the following mechanisms is most essential?
The Dynamics of a Wage-Price Spiral