The 6 Per cent Inflation Threshold and the Transmission of Nominal Wage Shocks to Inflation Expectations

Abstract

• This chapter explores whether the 6 per cent inflation rate matters for the transmission of shocks to inflation expectations. In addition, do inflation expectations update in response to shocks? Evidence establishes that the one-year-ahead and two-years-ahead inflation expectations increase in response to a positive shock to current inflation expectations. Existing inflation amplifies the one-year-ahead and two-years-ahead inflation expectations response to positive current inflation expectations shocks. This suggests that inflation expectations update following a positive shock to current inflation expectations and the degree to which they update is amplified by prevailing inflation. The results indicate that price stability matters.

   In addition, inflation relative to 6 per cent matters for the response of inflation expectations to shocks. Evidence shows that inflation above 6 per cent amplifies the response of the two-years-ahead inflation expectations more than when it is below 6 per cent. This means that price stability can help lower and anchor inflation expectations via its direct effects and as the amplifier of shocks. Overall, evidence in this chapter indicates that inflation expectations respond to shocks and their rate of updating is amplified when inflation exceeds 6 per cent. This means that the enforcement of price stability plays a role in minimizing the propagation of inflationary shocks.