Thinking Can Make It So: The Important Role of Inflation Expectations


The Issue:

Consumer prices rose 7 percent between December 2020 and December 2021, the third month in a row that this year-to-year inflation rate exceeded 6 percent.  This December figure is the largest 12-month increase in 40 years. A central concern now is whether inflation will be transitory or, instead, we are entering a persistently high-inflation period, like what occurred in the 1970s. The proximate causes of current inflation include supply chain disruptions, labor shortages and pent-up consumer spending. But another important source of ongoing high inflation is an expectation of high inflation among households and businesses.  How does the expectation of high inflation become self-fulfilling, and what proxies do we have to reflect this inherently unobservable but very important economic variable?

The Facts:

One source of inflation is when spending by people and companies strains the economy’s capacity for providing goods and services. Strains on the economy’s productive capacity can arise because of an increase in demand, constrictions to supply, or some combination of these two factors.  Currently in the United States and other developed countries it is the combination of high demand and constrained supply that is feeding inflationary pressures. Demand in the United States was supported through the first year-and-a-half of the pandemic by government support programs. Cash payments to individuals and families under the CARES act of March 2020, the CARES Supplemental Appropriations Act of December 2020 and the American Rescue Plan of March 2021 contributed to sharp increases in personal disposable income.  Spending may also have been boosted by low interest rates, which have increased the value of stocks, houses and other assets. Supply has been constrained because of a  2 percentage point drop in the share of the population participating in the labor force (either working or looking for a job).”

Continue reading here.

Posted by at 6:24 PM

Labels: Macro Demystified


Subscribe to: Posts