Opinion: Inflation psychology: Raising prices and getting away with it | 1RossGittins
Economists think inflation is all about economics. What they don’t know is that it’s also about psychology. But Reserve Bank governor Dr Philip Lowe shows a glimmer of understanding when he refers not to “inflation expectations” but to “inflation psychology”.
When last the rich world had a big inflation problem, in the second half of the 1970s and much of the ’80s, this theory seemed to work well, though it took years for expectations to worsen. Then it took years of keeping interest rates high and demand weak, and gettingThe inflation target, of 2 to 3 per cent on average, was set in the mid-90s to help “anchor” expectations at an acceptable level.
In the real world of price-setting by firms and workers, it takes a lot longer for expectations to shift prices than it does for prices in share and other financial markets to bounce around. But the breakdown of the inflation-expectations theory and the “wage-price spiral” as explanations of the relatively modern phenomenon of inflation – aA big part of it is the message those economists who specialise in studying competition have to give financial economists such as Lowe: you don’t seem to realise that our modern oligopolised economy gives many big businesses a lot of power over the prices they’re able to charge.
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