How Inflation Affects Wages

Inflation, i.e., the expansion of the paper (and electronic) money supply, affects wages in several ways:

  1. The expansion of the paper money supply happens unevenly.  That means that the people who control the supply of paper money determine the priorities for spending the newly printed paper money.  In the United States, the U.S. government, through the Fed (central bank), determines how the majority of the newly printed dollars are spent: they are spent on interest on debt; wars (military preparedness and homeland security); welfare; Medicare; enforcement of regulations, including drug laws; and an ever-expanding bureaucracy needed to institute ever more boon-doggles like Obamacare.  In the short run, while people still accept the paper currency in exchange for goods and services, workers who are working on government-favored projects get wage increases first while others see pay raises at a slower pace on a “trickle-down” basis.
  2. Because productivity, and therefore wages, are directly affected by the amount of capital invested in one’s job, we must also look at how inflation affects capital.  Inflation raises the cost of capital, making the capital more difficult to replace when it wears out.  It also chases capital away to a safer currency; i.e., some place with less inflation.  And if we combine inflation with high government taxation and wasteful spending, we get the consumption/destruction of capital.  This, too, reduces productivity and wages over time.  Imagine what it would be like if road crews had to use shovels and picks instead of large earth-moving equipment.  In time, if we destroy enough capital or have enough capital-destroying inflation, we could see those days again.
  3. Inflation also raises the prices of consumer goods, making it more difficult for wage-earners to make ends meet.  In other words, inflation affects the purchasing power of wages.  Because the price rises are gradual, people often don’t recognize this change immediately and fail to do something about it.  Yet, what can they do about a declining standard of living?  One of the biggest changes that has occurred during the last 50-60 years of inflation is that now it often takes two wage-earners in a family to make ends meet while back in the 1950s and 1960s it only took one.
  4. When wages no longer keep up with inflation, some people find it more advantageous to “retire” and seek employment in the underground economy (working for cash).  While this may, in some instances, be illegal (if they don’t report their cash income or if they earn more than allowed by law), more people will pursue this route as times become more difficult.  In short, inflation drives people into the underground economy to escape the mal-effects of government money-printing and high taxation.
  5. Inflation may drive some people to theft.  If it’s ok for the government to take by force from productive members of society, why shouldn’t individuals do so, as well?
  6. Lastly, a backlash against government “taking” grows.  A sentiment develops that says, I earned this money, not the government, why should I share it with the government.   What has the government ever done for me?  What gives them the right to take my hard-earned money?

On the other side of the coin are those happy just to find a way to live at government expense and not work.  When the incentive to work has been destroyed, society breaks down and wages aren’t paid anymore.  It becomes a free-for-all with everyone looking out for themselves…

Thus endeth the story of how inflation affects wages (every time).

Robert Jackson Smith

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