Rational and Non-Rational Expectations of Inflation in Wage Equations for the United Kingdom

Expectations of inflation are widely recognized as playing a key role in the determination of the rate of change of money wages. Yet there is no widespread consensus on the size of the coefficient on the inflation expectations variable in the wage equation. Sargan (1980), for example, could not obtain statistically significant coefficients on this variable. Using a long Almon distributed lag of rates of change of prices as a proxy for expected inflation, Sargan found that the estimated weight distribution was implausible and the total coefficient was negative and insignificant: The use of the independent estimate of price expectations provided by Carlson and Parkin led to estimates of the coefficient on expected inflation in the range 0 14-0 16, and in no case was it significantly different from zero. Henry and Ormerod (1978) substituted the actual rate of inflation for the expected rate, and estimated the resulting equation by instrumental variables. They obtained coefficients in the range 0 24-0 36, most of which were significantly different from zero. The aim of this paper is to carry out a systematic comparison of different methods of expectations formation, in the context of one particular wage equation estimated in every case over an identical sample period. The results are, of course, specific to the equation and sample period used in this paper, and do not necessarily illustrate a general point. The equation used, however, is of a form that has obtained widespread empirical support in the UK literature. In this context, the paper provides useful evidence that the coefficient obtained on the expected price inflation terms in wage equations depends to a certain extent upon the method of forming expectations that is postulated, although a wide variety of expectations generating mechanisms do not yield results that are statistically significant from one another. The methods used in the paper are two autoregressive schemes, substituting actual price movements for the expected inflation term; finally, an attempt is made to incorporate the concept of rational expectations

Context (archaeology) · Econometrics · Economics · Inflation (cosmology) · Labour economics · Proxy (statistics) · Rational expectations · Sample (material) · Simultaneous equations model · Statistics · Wage · Economic theories and models · Economic Theory and Policy · Mathematics · Monetary Policy and Economic Impact

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