The rising labor costs that result cause the costs of production to increase. Businesses are then forced to increase prices, thus causing inflation. The inflation diminishes purchasing power and export sales decline so output falls. All of this causes the inflationary gap to close. Demand Inflation and Stagflation the real problem in a period of an inflationary gap is aggregatedemand.
Most people blame inflation on higher wages and such.
In reality, they are just symptoms of the increasing demand for labor and other goods. It is the excessive aggregate demand that causes the inflation. We just see it represented in the wages and prices. Look again at figure 11-6. Notice that we had output fall while prices rose.