Labour shortages and inflation

Why Rising Wages Cause Inflation

• If wages rise, firms will try to pass on the cost increases to customers – leading to cost-push inflation.
• If wages rise, workers have an increase in income leading to higher disposable income and higher spending – this can cause demand-pull inflation.

However, it is possible that even with a shortage of labour we may avoid inflation.

• If firms have monopsony power and can avoid paying higher wages despite the shortage
• If vacancies are being filled by migrants from abroad. (though you could say if migrants can enter the labour market then there isn’t a shortage, but, in the boom years of 2003-07, migrant labour was important for keeping inflationary pressures low in economies like Ireland and UK.
• If other inflationary pressures are muted. A shortage of labour puts upward pressure on wage increases, but, other factors affect inflation. If interest rates are being increased and the economy is experiencing efficiency savings, overall inflation may not be affected very much

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Causes of demand pull inflation

What are the main causes of Demand-Pull Inflation?

1. A depreciation of the exchange rate increases the price of imports and reduces the foreign price of a country's exports. If consumers buy fewer imports, while exports grow, AD in will rise – and there may be a multiplier effect on the level of demand and output
2. Higher demand from a fiscal stimulus e.g. lower direct or indirect taxes or higher government spending. If direct taxes are reduced, consumers have more disposable income causing demand to rise. Higher government spending and increased borrowing creates extra demand in the circular flow
3. Monetary stimulus to the economy: A fall in interest rates may stimulate too much demand – for example in raising demand for loans or in leading to house price inflation. Monetarist economists believe that inflation is caused by “too much money chasing too few goods" and that governments can lose control of inflation if they allow the financial system to expand the money supply too quickly.
4. Fast growth in other countries – providing a boost to UK exports overseas. Export sales provide an extra flow of income and spending into the UK circular flow – so what is happening to the economic cycles of other countries definitely affects the UK

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