Inflation expections, income expectations & financial repression

The Federal Reserve Bank of San Francisco published a letter titled, Consumer Inflation Views in Three Countries, written by Bharat Trehan and Maura Lynch. The letter explores inflation expectations among consumers in the UK, US and Japan. Basically the story is that inflation expectations by consumers are tied to the level of oil prices and recent inflation. Policy adjustments by a central bank do not play much of a role in determining their inflation expectations.

The inflation expectations of consumers are important to evaluate the spending and wage demands of consumers. If consumers raise their inflation expectations, they would bargain for higher wages, only if they have power to do so. Labor has little power nowadays to bargain for better wages.

So what the letter from the FRBSF is missing is a comparison between what consumers expect of inflation and what they expect from their own incomes. Simply put, if I expect inflation to be 3%, but expect my own income to rise at around 0%, then I feel I am losing ground… and I will be less likely to spend money. Surely it makes more sense to spend money now since prices are rising faster than I can keep up with them, right? No… Spending more money now would make me feel even more insecure.

People tend to watch their spending because they feel vulnerable and uncertain about inflation. They hold onto their money because their incomes are not keeping up with inflation.

The very low interest rates are another factor in holding back spending by consumers. If I feel my income is growing at 1% and my savings are growing at less than 1%, then I feel even more vulnerable to 3% inflation and will hold onto my money to survive through the long-run… and I mean long-run for years and years, because labor/consumers do not see their plight changing anytime soon. They are concerned about saving for the future too.

The real problem with monetary policy is that there is no transmission mechanism to get liquidity into the hands of consumers. Consumers are dependent upon firms to raise their incomes, and firms have little incentive or weakness to substantially raise the incomes of labor.

So when inflation expectations are higher than the inflation target, higher than actual inflation and higher than income growth, it is a sign that consumers feel vulnerable and weak in comparison. Spending will be weak too.

If the Fed was to raise their interest rate, the return on savings for consumers would go up, and consumers would feel a bit more empowered to spend. Of course, the government would have to pay more to service its debt, but consumers would feel secure to spend more. Thus, we see a form of financial repression at work which has the effect of suppressing consumer spending to the advantage of the government and owners of capital.