Autonomous Wage Inflation

This paper develops a theory of stagflation, based on
turnover-efficiency-wage theory. In these theories, wages are
forward-looking, i.e., set to keep incumbents with the firm. The
employed workers apply for better jobs and compete with unemployed
applicants. An employed applicant is, however, preferred to an
unemployed applicant, or the long-term unemployed, who, with their
outdated skills, form an essentially non-competing group. Consider
now the case that the monetary authority succeeds in stabilizing
the price level permanently. Start from efficiency-wage
unemployment equilibrium. The skills of the unemployed will, after
a while, become outdated. This reduces the „effective” rate of
unemployment and causes the labor market to tighten. Turnover
increases, and the former equilibrium is destroyed. The individual
firm will raise wages in order to reduce turnover costs. Costs
increase, causing prices to also increase. The monetary authority
reacts with restrictive policies, and unemployment increases. This
leads to a new turnover-efficiency-wage equilibrium, and the
process continues. The argument implies that wage inflation emerges
after a while at all employment levels. This paper concludes by
discussing some of the consequent policy implications.