Why inflation expectations can be a self-fulfilling prophecy
The Reserve Bank of Australia (RBA) has raised the cash rate over the past couple of years to combat inflation and, now that inflation has been falling to more reasonable levels, may reduce the cash rate in the near future. So there was much interest in a speech that RBA Assistant Governor Sarah Hunter recently gave about inflation expectations.
“Macroeconomists generally think that a prerequisite for consistently achieving low and stable inflation over time is well-anchored inflation expectations,” she said.
That’s because if workers believe inflation will be high, they will ask for higher wages; and if businesses believe prices will be higher, they will feel more confident about offering higher wages to attract workers. Both actions will lead to higher inflation. That’s why inflation expectations can be a self-fulfilling prophecy.
Ms Hunter said the RBA was “constantly alert for signs” that inflation expectations were no longer well-anchored, but added that the RBA was “not currently concerned that expectations could become de-anchored in the near term”.
Ms Hunter’s speech did not offer any signals for when the RBA might start reducing the cash rate. As a result, it would be prudent to keep budgeting for higher interest rates.
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