Mechanism of Accelerating Inflation from Low Unemployment and Positive Expectations
When unemployment is kept below its equilibrium level, a positive bargaining gap emerges. This gap, combined with positive inflation expectations, leads workers to demand higher nominal wages. Firms, in turn, raise prices to protect their profit margins. This process becomes self-perpetuating: the resulting inflation feeds into higher future expectations, which, along with the persistent bargaining gap, drives a continuous acceleration in the inflation rate.
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