How much does inflation cost workers? The answers to this question focus on the behavior of real wages during periods of inflation. We argue that workers have to take costly actions (“conflict”) to keep nominal wages up to inflation, meaning that there are social costs even if real wages do not fall as inflation rises. We study a menu-style model of costs, in which workers choose to engage with employers in order to obtain wage increases. We show that, after inflation, wage accumulation caused by common conflicts does not raise welfare. Rather, the impact of inflation on workers’ welfare is determined by what we call “wage erosion”—how inflation can reduce real wages if workers’ conflicting decisions do not respond to inflation. As a result, measuring welfare using observed wage growth understates the cost of inflation. We conducted research that shows that workers are willing to give up 1.75% of their salary to avoid conflict. Estimating the model on survey data, the aggregate cost of inflation that includes friction more than doubles the cost of inflation with only falling real wages.
That new paper is coming out
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