The most common source of cost-push inflation is held to be the power of trade unions to gain wage increases, which then leads to rises in prices, which in turn spark off further wage claims, etc.
CRITICS OF this theory argue that if trade unions succeeded in raising wages and prices at times when the level of aggregate demand has not risen by enough to justify this, there would be a tendency for unemployment to increase, with subsequent deflationary effects in the economy. Such a process could not continue indefinitely, and therefore cost-push certainly could not explain the persistent inflationary processes in virtually all the economies since the Second
World War.
Either the price increases must be 'ratified' by stimulation of aggregate demand to prevent the unemployment, or the inflation in fact is due to excess demand in the first place. This latter proposition essentially argues that advocates of the cost-push theory mistake the mechanism of adjustment for a motive force of the process. Suppose that when firms experience increased demand for their products, they do not raise prices, but instead attempt to increase output by increasing overtime, employing more workers, etc.
This increased demand in the labour market then leads to increases in wage earnings and wage rates (these increases taking place in negotiations between unions and employers). As a result of these wage increases, firms are forced to raise prices. Clearly, however, the motive force for the price rises came from the demand increases: the wage negotiations are simply the mechanism by which excess demand is translated into price increases. The argument that inflation is caused either by ratification of increases, or simply by excess demand in the first place, has important implications for the control of inflation. If the purely cost-pus theory is accepted, then either the government must sit back allow unemployment to develop, or it can try to intervene in bargaining process with political/administrative measures to restrain unions in their demands for inflationary wage claims.
