How costly is inflation to workers? Answers to this question have focused on the path of real wages during inflationary periods. We argue that workers must take costly actions (“conflict”) to have nominal wages catch up with inflation, meaning there are welfare costs even if real wages do not fall as inflation rises. We study a menu-cost style model, where workers choose whether to engage in conflict with employers to secure a wage increase. We show that, following a rise in inflation, wage catchup resulting from more frequent conflict does not raise welfare. Instead, the impact of inflation on worker welfare is determined by what we term “wage erosion”—how inflation would lower real wages if workers’ conflict decisions did not respond to inflation. As a result, measuring welfare using observed wage growth understates the costs of inflation. We conduct a survey showing that workers are willing to sacrifice 1.75% of their wages to avoid conflict. Calibrating the model to the survey data, the aggregate costs of inflation incorporating conflict more than double the costs of inflation via falling real wages alone.

More on this topic

BFI Working Paper·Feb 11, 2025

Income Equality in The Nordic Countries: Myths, Facts, and Lessons

Magne Mogstad, Kjell G. Salvanes, and Gaute Torsvik
Topics: Economic Mobility & Poverty, Employment & Wages
BFI Working Paper·Jan 21, 2025

Effects of Unemployment Insurance for Self-Employed and Marginally-Attached Workers

Emilie Jackson, Dmitri Koustas, and Andrew Garin
Topics: Employment & Wages
BFI Working Paper·Nov 14, 2024

Assortative Matching and Wages: The Role of Selection

Katarína Borovičková and Robert Shimer
Topics: Employment & Wages