Inflation: Why What You Think Matters
WSJ ECONOMICS BLOG
As with all self-fulfilling prophecies, inflation expectations play a huge role in determining future inflation. Why? Because firms have to make wage and price-setting decisions for future periods of time. If they think inflation is going to rise, they?ll raise their prices to compensate. Those higher prices are passed on to consumers, who demand higher wages in what?s known as a ?wage-price? spiral in economics.
Right now, inflation expectations are on the rise. Consumers think inflation will be north of 5% over the next year based on various recent surveys, and treasury data shows investors? expectations are rising as well (See related story).
Prices and expectations are rising now specifically because of higher costs for oil and other commodities. Firms (like Dow Chemical Co.) are raising prices to cover ?staggering? energy cost increases. Consumers are feeling the heat at gas pumps (where gas now averages nearly $4 a gallon) and in grocery stores. But the classic "wage-price" spiral isn't in place, because the economy is weak and unemployment is rising, so workers are reluctant to threaten their job security by asking for raises. In fact, average hourly earnings continue to lose steam.
Yet inflation is rising anyway. And once inflation expectations begin to take hold, it?s the Federal Reserve?s task to bat them down. ?Price stability is our responsibility as central banks,? said Fed vice chairman Donald Kohn in 2005. ?It is how, in the long run, we contribute to society?s welfare.?
Other Fed policymakers have stepped up recently to acknowledge the unwelcome rise in inflation expectations, hoping to reassure the public they?ll keep prices under control (markets now price in the possibility the Fed will raise rates at its June 24-25 policy meeting).
?The public could mistakenly see the stance of policy as a sign that our commitment to long-term price stability has wavered,? Fed governor Kevin Warsh warned attendees at a luncheon last week in Washington, D.C. ?Credibility could be undermined, threatening to create a persistent inflation problem that would have to be corrected, no doubt at great cost.? –Kelly Evans |
