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How Human Psychology Explains the Return of Inflation

Adding to all the mechanical and mathematical rules of the standard model, [it] We can gain a lot more in understanding what the hell is going on with the economy.

But there’s something here that the standard model doesn’t easily capture, according to Lowe. That is the “general inflation psychology in the community.

“Before the pandemic, it was very difficult for business people to stand in the square and say they were raising prices. [regular interviews with business people] Wage increases had to be modest because most companies struggled to raise prices.

way to think? way to think? It is a word that does not appear in economics textbooks. There are no equations or charts in the way of thinking.

Today, however, “a business person can stand in a public square and say they are raising prices, and I can point to a number of reasons why.

The community doesn’t like it, but it’s accepted grudgingly. And when prices rise, it becomes harder to resist significant wage increases, especially in a tight labor market,” said Lowe.

“So the psychology changes. Or, as the Bank for International Settlements said in its recent annual report, if inflation is high, it becomes an adjustment mechanism for pricing.

So people start really paying attention to changes in costs and prices. As a result, cost shocks can be passed on more quickly and fully, and price and wage adjustments can be made more frequently. ”

“There’s some evidence that it’s already happening, and that’s contributing to the resilience of inflation,” Lowe added in a speech earlier this month.

To be fair, this is just the latest version of the paper, or “model”. Lowe has developed over the years. And I think he’s dealing with all the mechanical and mathematical rules of the Standard Model, plus a phenomenon that takes us farther in understanding what’s going on in the economy. increase.

It adopts the standard model, but contrary to that assumption, humans are social animals, and the economy’s “agents” – consumers, bosses, workers, union secretaries, etc. I admit that I have a tendency to

In financial markets, you can always observe it. We feel comfortable when we are doing what others are doing. We feel uncomfortable when we go against the herd.

Financial markets are a good indicator of our grazing behavior.credit:APs

Like many economists and academic economists, anyone who has worked in business for a while knows that business behavior is strongly influenced by trends and fashion. One of the roles of stock market analysts is to punish unfashionable companies.

Economists around the world spent a lot of time during the global financial crisis and pandemic trying to explain why all rich economies fell into a “secular stagnation”, or low-growth trap.

I think Rowe has found a big piece of that puzzle. Business has gone through this strange period for many years. their price.

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Inflation has remained below the reserve target band for years. Productivity gains have regressed and economic growth has been tepid as firms no longer have reason to invest much.

But then came the pandemic, lockdowns, huge budget and financial stimulus packages, border closures to immigration, and finally, massive supply shocks from the pandemic and the war in Ukraine.

Suddenly, some big price increases are announced, the dam bursts, and everyone from big corporations to corner milk bars start raising prices. The spell has been broken, and I don’t think we can return to the strange world we once lived in.

But the other side of the world without price hikes was obsessed with using every possible means, legal or illegal, to cut labor costs. Significantly enhanced low-growth traps. But it was also made possible by various developments that robbed workers of their bargaining power.

It is not yet clear whether the end of the ban on self-imposed price increases coincides with the end of the ban on proper wage increases.

Ross Gittins is the economics editor of the Sydney Morning Herald.

How Human Psychology Explains the Return of Inflation

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