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Inflation is Not Fueled by Increased Economic Productivity

Here’s a letter to the Wall Street Journal; the analogy that I use isn’t perfect, but it works, I think, to help to debunk the myth that inflation is necessarily fueled by rising wages:

Connecting Friday’s big sell-off on Wall Street to Friday’s favorable jobs report, you write that “[m]arkets interpreted the growth in wages as a signal of higher inflation….  But increasing the return on labor does not guarantee inflation” (“The Selloff Arrives, Finally,” Feb. 3).

The point is far stronger than you suggest.  When wage growth reflects rising worker productivity, as it almost certainly does at present, it means increased output of goods and services.  Increased output of goods and services, in turn, puts downward pressure on inflation: each unit of money buys more goods and services than it would buy otherwise – which is to say that nominal prices wind up lower than otherwise.

Worrying that rising wages in a well-functioning market economy might cause inflation is akin to worrying that rising temperature readings on a well-functioning thermostat might cause the heater, not to maintain the room at a comfortable temperature, but to pump into the room uncomfortable amounts of additional hot air.

Donald J. Boudreaux
Professor of Economics
Martha and Nelson Getchell Chair for the Study of Free Market Capitalism at the Mercatus Center
George Mason University
Fairfax, VA  22030