The Several Effects of Anticipated Inflation

Abstract

The purpose of this paper is to examine the effects of an increase of anticipated future inflation in a general equilibrium model. In the comparative statics approach taken here an attempt is made to bring together the several theoretical effects which have been presented in the literature. While the results of this inquiry suggest that inflationary expectations have a variety of effects which often conflict, they also show the necessary conditions in the economy which determine whether inflationary expectations will lead to increases in employment and output. The approach taken in this paper is unique since it attempts to differentiate between effects of currently held expectations of the current price level and the future inflation rate. This approach is necessary because the reasons for uncertainty about current prices are quite different from those which explain uncertainty about future prices. The paper treats the future inflation rate as an exogenous variable and examines the effects of an increase in the anticipated future inflation rate. The size and direction of the results depend upon how accurately agents are able to perceive current prices. Making these distinctions we come to a unique and somewhat surprising policy prescription of lowering aggregate demand as a way of simultaneously lowering both inflation and unemployment rates. We also find that jawboning efforts designed to point the finger of blame at firms and which allow unions free reign can be highly counterproductive in an inflationary world. The second section of this paper briefly discusses some of the theoretical literature on inflationary expectations. The third section describes a general equilibrium model with inflationary expectations. The fourth section performs a comparative static exercise which shows the effects of an autonomous increase in expectations of the future inflation rate upon real wages, employment, output interest rates, wages, and prices. The various results are shown to depend crucially upon misperceptions of current prices which are themselves dependent upon the relative costs of information gathering of firms and households. Section V summarizes the findings and comes to a few policy conclusions.