Will cost-of-living raises push inflation even higher? Maybe, but the effect is small

Rayna Song

As U.S. inflation hit a 40-year high of 8.6%, critics of cost-of-living wage adjustments – changes in pay meant to offset inflation – saw COLAs as further fueling price increases. 

Last November, John Deere's union employees ended a strike of more than a month after winning a contract that included a 20% increase in wages over six years and more retirement benefits. Particularly, it brought back cost-of-living adjustments, with Deere employees’ wages to be adjusted every three months.

After Kellogg workers ended a longer strike with a contract that included COLAs, the Wall Street Journal editorialized that such wage increases, popular during the inflation of the 1970s, are "an economywide problem when they become part of a wage-price spiral." 

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Some economists agreed, suggesting that COLAs could increase consumer demand and thus boost inflation, while others discounted the effect, saying the adjustments affect the income of a very limited number of employees.

The United Auto Workers union represented Deere employees, and UAW President Ray Curry told USA TODAY the labor union “has always advocated for COLA, but more and more members these days are wanting it in their contracts.” 

“Members are ready to band together to seek improvements in wages and benefits that they deserve. We do not view COLA as having a large impact on inflation, because union members represent a small percentage of manufacturing employees,” Curry said by email. 

Mark Zandi, chief economist of Moody's Analytics, concurred, noting that too few union members benefit from the raises to create a broad impact. The nation's union membership rate of workers was 10.3% in 2021, according to the U.S. Bureau of Labor Statistics

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Mark Zandi speaks during a live taping of "Meet the Press" at the NBC studios on Jan. 11, 2009, in Washington.

'Unemployment is going to rise'

Zandi said that although workers want to be compensated in a high inflation environment, and more union members might want to demand COLAs, it will become difficult to negotiate as the Federal Reserve slows the economy. 

“The job market is going to weaken. Unemployment is going to rise, and therefore it's going to be much more difficult for workers, unions to succeed in their demands for COLA,” Zandi said.

Mark Mathews, vice president of research development and industry analysis at the National Retail Federation, said COLAs could potentially impact inflation because employees might have more money to spend, shifting demand. 

It also depends on how COLAs calculate inflation – the consumer price index or the personal consumption expenditures price index, the latter of which is lower and could better reflect underlying inflation trends, he said. Workers could potentially get raises that outpace the actual cost of living if inflation is not measured accurately. 

U.S. inflation reached 8.6% in May.

Is a wage-price spiral happening?

Some experts were concerned that cost-of-living adjustments would lead to a wage-price spiral, where wage increases cause price increases, which in turn cause wage increases. 

Sinem Buber, lead economist at ZipRecruiter, said this vicious inflation cycle has not occurred yet, evidenced by the fact that wage growth rates do not correlate to price increases in the same industry. For example, energy inflation is up by 34.6% compared with last May, but wages in the energy industry have decreased by 8.2% over the same period, according to the U.S. Bureau of Labor Statistics.

“We cannot say that it’s labor costs that increase the prices for particular industries,” Buber said. “But that doesn't mean that we're not going to get there (wage-price spiral soon). We're not in the wage-price spiral yet, but we are at the verge of it.”

She said prices respond to changes much faster than wages, and we are currently in a phase of wages lagging behind prices. Right now, when employers consider input costs, wage increase is often a smaller concern than gas or food price spikes, Buber added. 

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Zandi agreed the wage-price spiral has not happened yet and suspected the Fed would push the economy into a recession by raising interest rates aggressively before the vicious cycle takes hold. 

The Fed "believes that it’s better to suffer a near-term, milder recession, get inflation down than let inflation become endemic, more persistent, and ultimately have to suffer a much more prolonged and severe downturn,” Zandi said.

Wage increases slower than price

Consumer prices have increased by 8.6% over the last year. During the same period, wages went up by 6.1%, according to the Atlanta Fed's wage growth tracker. Because inflation outpaces wage growth, average U.S. workers are losing their purchasing power despite getting larger paychecks.

Buber said wages used to increase around 2.5% every year before the pandemic, and the current high wage growth is partly caused by talent shortages, as two jobs are open per each unemployed person in the economy, according to the U.S. Bureau of Labor Statistics

“The main reason for the high wage growth right now is the tight labor market. It's the severe labor shortages,” Buber said. “If you think from the employer's perspective, half of the jobs … do not get any applicants, and the other half get only one applicant. It’s very fierce. Employers are going through trouble attracting workers.”

Social Security COLA calculation

Another factor in cost-of-living adjustments, different from negotiated wages, is the Social Security system. Social Security benefits for approximately 64 million Americans increased by 5.9% in 2022. The Social Security COLA is announced in October every year. 

Mary Johnson, a Social Security policy analyst for the Senior Citizens League, said 5.9% is falling short of the inflation rate, and many Social Security beneficiaries do not have savings, making them reliant on pension benefits and vulnerable to price increases. 

“If prices are going up, the way they are doing right now, and (beneficiaries) don't receive some adjustments for the cost-of-living in retirement, that leaves people really floundering and in a dire situation, if they don't have enough money when they go to the gas pump,” Johnson said.

She said more retirees visited a food pantry or applied for Supplemental Nutrition Assistance Program benefits, spent emergency savings and applied for rental assistance this year compared with last year, demonstrating how inflation impacts the elderly population.

“They don't necessarily have resources to deal with these rising prices and bad situations. They can't afford rent; they can't afford food. They can't afford their prescription drugs, and you're talking about things people need to have, to function in a society,” Johnson said.