Workers’ wages are rising. Home Depot, Delta Airlines, and Walmart are some of the latest companies to announce substantial pay hikes. Yet, most economists have reservations about these gains. Their fear is that rising wages will fuel already-high inflation on two fronts: first by providing consumers with income for spending that the economy can’t handle, and second by driving up the cost of labor for companies. Both could lead to higher prices.

But some argue that pay gains are long overdue. By some measures, wages stagnated from the late 1970s until just a few years ago. The pandemic gave them a boost. And despite reports of a rebalancing of the power between workers and their bosses, once adjusted for inflation, worker pay has actually shrunk. 

Even if the pace of wage increases did exceed the rate of inflation, resulting in rising ”real” wages—some argue that this won’t necessarily translate into higher inflation. In a recent paper, several leading labor economists found that labor market tightness has allowed workers not only to negotiate higher pay, but to move into more productive roles. If workers produce more per hour, they can be paid more without companies having to raise prices.

There is also limited historical evidence of worker pay driving inflation. In their recent World Economic Report, the International Monetary Fund looked at 22 historical periods in advanced economies over the past 50 years with conditions similar to today’s. Their conclusion: wages more often react to inflation than cause it.

But many economists think this time is different. They argue that, while wages may have been rising thus far as a reaction to bottlenecks elsewhere in the economy, this could now change. If workers come to expect higher inflation in the future, they will bake this into their wage demands, forcing companies to raise prices. This cycle, in which the expectation of higher inflation turns into a self-fulfilling prophecy, is the so-called “wage-price spiral” that central bankers are trying to avoid.

In order to head this off, the Federal Reserve is raising interest rates in the hopes of slowing the economy and halting the spiral before it takes hold. The thinking is that, in a weaker economy, it will be harder for workers to demand higher pay. And as people earn less, they will spend less, making it tougher for companies to continue raising prices.

But making the case to the public has not been easy. 

Wage growth is the third rail of monetary policy. Central bankers' technocratic arguments about engineering stable wages and prices are often interpreted as views about the distribution of profits between labor and capital. Early last year, Bank of England governor Andrew Bailey was rebuked by the Prime Minister and pilloried in the British press for suggesting workers moderate their wage demands. 

Another complication is that, because changes in interest rates only affect the economy with a lag, central bankers are taking action today in response to the specter of a wage-price spiral that has not yet materialized. As Federal Reserve Chairman Jerome Powell recently put it, “You don’t see [a wage-price spiral] yet. But the whole point is . . . once you see it, you have a serious problem. That’s what we can’t allow to happen.” 

The aggressive approach policymakers are adopting probably stems at least in part from the lessons they learned after failing to control inflation in the 1970s. Back then, after turmoil in the middle east caused oil prices to soar, unions were able to secure higher pay through collective bargaining agreements. This unleashed a wage-price spiral that drove inflation to almost 15%. In response, Fed chairman Paul Volcker hiked interest rates to 20%, bringing down prices, but at an enormous cost: a deep and prolonged recession in which unemployment rose to almost 12%. 

To some extent, it doesn’t matter whether higher wages are driving inflation or responding to it—the monetary policy prescription is the same: hike interest rates. If too much demand is the issue, making borrowing more expensive will reduce it. And if workers are demanding wage increases in the expectation of future inflation, higher interest rates will slow the economy and erode their bargaining power. 

There are ways inflation could subside without a recession. More people could re-enter the workforce, stabilizing the imbalance between the supply of workers and demand for them. The economy could slow just enough to pull job vacancies down without causing higher unemployment. Companies could reduce their profit margins, breaking the link between higher wages and higher prices. 

But most economists believe that only a strong enough dose of higher interest rates to induce a recession will restore price stability. Business and academic economists polled by the Wall Street Journal put the probability of a recession in the next 12 months at 61%—a historically elevated level of pessimism outside actual recessions. If those forecasts are right, central bankers will get exactly what they want, while those hoping for higher real wages will have to wait.