An economy is experiencing a period where wage demands consistently outpace productivity gains, creating a positive 'bargaining gap' of 2%. If the inflation rate last year was 3%, and people form their expectations about future inflation based on last year's rate, what will the inflation rate be this year?

Inflation Dynamics with a Persistent Bargaining Gap

Inflation Dynamics with Adaptive Expectations

In an economy where inflation expectations are formed by looking at the previous period's inflation rate, a persistent positive bargaining gap will cause the inflation rate to stabilize at a new, higher level.