Ed Peters
October 20, 2021

Central banks in the developed world have been saying that while headline inflation is high, the level is temporary and inflation expectations remain “well-anchored.” Central bankers have generally based policy on the idea that permanent rises in inflation occur when consumers expect inflation to rise. This makes inflation expectations a self-fulfilling prophesy. So as long as long-term expectations remain low, the central bankers are less worried about a rise in short-term expectations. The numbers have supported this view. The University of Michigan survey of consumers, for instance, shows that while one-year expected inflation has risen from 2.6% in October 2020 to 4.8% in October 2021, the five-year number has barely moved. It has risen from 2.4% to 2.8% over the same period. Break-even rates from inflation-linked bonds tell a similar story.

Yet, at the end of last week, we saw an interesting shift in labor markets. Workers at Deere began a strike for higher wages, and the film industry barely avoided one of its own. Other unions are intimating they too will use strikes as leverage. This is partly due to anger about working conditions. Many workers feel they were on the front lines, facing the risks of catching COVID-19, and deserve higher pay. In addition, workers may feel that the labor shortage gives them the upper hand. But it’s also possible that these are the first signs of a rise in long-term expected inflation. In the late 1970s and early 1980s, rising inflation expectations resulted in steady cost of living raises; 10% used to be normal and expected by workers. We shouldn’t dismiss the idea that these strikes are the first vestiges of rising long-term inflation expectations. If so, the central banks will have no choice but to raise interest rates more dramatically than they currently envision.

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