A Partial Adjustment Model of Interrelated Prices and Wages with its Applications to Korea and Japan

Abstract

One of the most controversial issues in the relations between wages and prices is whether inflation is caused by an increase in wages or an increase in wages is caused by an increase in the living costs due to inflation. A series of statements by government authorities strongly supports the idea that the level of prices can be stabilized by suppressing an increase in wage rates. This idea is not novel. Standard economics admits that the wage is an important item in the production costs and that an increase in the wage rates causes an increase in costs which, in turn, causes an increase in the general price level. This process is known as the costpush inflation. If inflation of our real world is due to the cost-push process, then the suppression of an increase in the wage rates is certainly an effective device to cure inflation. But the relation between wages and inflation may be the other way round. According to the demand-pull theory of inflation, inflation is caused by an excess demand in general relative to the aggregate supply. If an excess demand causes inflation, inflation, in turn, increases the cost of living, which leads to an increase in the wage rates.