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inflationary expectations and wage inflation

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On July 20, 1993 Alan Greespan, chairperson of the Board of Governors of the Federal Reserve System, testified before a congressional committee. He said: "The role of expectations in the inflation process is crucial. Even expectations not validated by economic fundamentals can themselves add appreciably to wage and price pressures for a considerable period, potentially derailling the economy from its growth path."

(a) If workers are convinced that inflation is about to increase greatly, what effect does this have on their wage demands? Do their wage demands fuel further inflation?
(b) If the managers of firms are convinced that inflation is aobut to increase greatly, what effect does this have on their pricing decisions? Do their pricing decisions fuel further inflation?
(c) How can inflation derail the economy from its growth path? Cite cases in the past where inflation derailed the U.S. economy from its growth path. Be specific.

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Solution Summary

The relationship between inflationary expectations and wage inflation is explained in terms of the labor market bargaining process.

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