![]() ![]() As such, the stability of long-run inflation expectations is a sign that households have confidence that the Federal Reserve will achieve low inflation over time. By reducing demand, ongoing monetary policy tightening will help reduce the probability that this risk materializes. Given the large increase in short-term inflation expectations in the past year, our results point to an important upside risk to inflation, as workers demand higher wages that businesses could pass on to consumers by raising prices. In this Economic Letter, we show that year-ahead inflation expectations have a large impact on wage inflation, while long-term inflation expectations have essentially no influence. Therefore, future wage inflation depends in part on its sensitivity to short- and long-run inflation expectations. In April 2022, year-ahead expected inflation was up to 5.4% before receding slightly to 5.2% in July. While the inflation rates that households expect over the longer run remain fairly stable, year-ahead inflation expectations have risen substantially since early 2021. However, if inflation remains very high, workers may expect it to persist and demand higher wages to match the rising cost of living (Lansing 2022). Thus, it was likely not a major factor in wage negotiations until recently. This increase in inflation was mostly unanticipated and expected by many to be temporary. As a result, real wages, which adjust for the rising cost of living, have declined. The 12-month change in consumer price inflation has risen from 1.4% at the start of 2021 to more than 9% in June 2022. However, the substantial nominal wage gains have not been enough to compensate for the rise in inflation over the past year. Other measures, such as employment wage costs that control for worker shifts between occupations and industries, are up almost as much. Wages were growing about 3% annually before the pandemic, when the labor market was also tight now, average hourly earnings are growing at roughly twice that rate, and even more in some sectors hit hardest during the pandemic, such as leisure and hospitality. ![]() Reflecting the difficulties businesses face in finding workers, wages have climbed substantially. Employment is back at pre-pandemic levels, job openings are surpassing the number of unemployed workers, and people are quitting jobs at high rates. labor market has rebounded strongly from the deep pandemic-related recession and is now very tight. This points to an upside risk for inflation, as workers negotiate higher wages that businesses could pass on to consumers by raising prices. Given this divergence, what role do short-run and long-run household inflation expectations play in determining what workers expect for future wages? Data show that wage inflation is sensitive to movements in household short-run inflation expectations but not to those over longer horizons. Households are currently expecting inflation to run high in the short run but to remain muted over the more distant future.
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