Wage-push inflation

Wage-push Inflation 

This type of inflation is caused by rising wages. Since wages is a factor of production, as it rises, cost of production increases. Thus, this shifts the short run Aggregate Supply to the left. As a result, general price level of goods increase as producers pass on the high costs of production to domestic consumers by jacking up the prices. For example, industrialized Western economies such as the UK and Germany saw the rise of trade union power in the mid-20th century, which made wage-push inflation a main concern for these economies.

Solutions

One short run policy would be intervention by the government on wage setting with an aim to influence the rate of inflation. For example, government passes legislation to limit rises in wages. It operates through the SRAS curve and is classified as a SSP. This can take various forms such as wage freeze or wage reduction in the public sector.

In Singapore, the National Wages Council (NWC) determines the appropriate wage increase with the economy's well being as its priority. Also, the NWC meets annually to make recommendations for wage increases. This ensures that wage increases do not exceed productivity gains, thereby maintaining unit labour costs. This will prevent the SRAS curve from shifting to the left, thus eliminating wage-push inflation.

However, there are limitations to this policy. The allocative function of the price system tend to interfere with effective wage controls. Factor prices must be allowed to fluctuate freely and fully in response to changing market conditions, i.e. to changes in demand, factor supplies or technology in order for allocative efficiency to be sustained through time. Effective wage controls would prohibit the market system from making these adjustments.

One long run policy would be skills upgrading which aim at raising the level of labour productivity. If the increase in labour productivity is higher than wage increases, the unit cost of production will decrease and hence the SRAS curve will shift to the right, hence lowering the rate of inflation.