Dynamic concept Inflation and yield

Low wage and low inflation

In my October 9 note, I identified two positive feedback mechanisms inner to the inflation feedback control loop. These positive feedbacks make it difficult to control inflation to the target.

There are a couple problems in measuring inflation. First, as the conceptual model in my note on September 29 revealed, some of the inflation components or their linear combination might belong to uncontrollable space, i.e., they can not be driven to the values where one wants them to be, no matter what control strategies are adopted.

Second, wage serves both a mechanism to control inflation and a component to measure inflation. This creates a dilemma as wage is often inflation indexed. In the low inflation environment, employers will give small wage increases to employees, and small wage increases will contribute less to inflation.

For control purpose, inflation measurement should exclude those components which are uncontrollable. For wage index purpose, a subset of inflation excluding wage should be used.

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