Inflation expectations matter more than unemployment

Significance

The surge in inflation this year owes more to supply bottlenecks caused by the release of pent-up demand than to falling unemployment. In the decade before the pandemic, US unemployment more than halved and euro-area unemployment nearly halved, but inflation remained below target in both economic areas.

Impacts

• Central banks face the dilemma of raising rates too early for growth and too late for inflation, and may struggle to dampen expectations.
• The threat of a possible revival of the pandemic will help temporarily to cool inflation expectations that have surged in 2021.
• The trade-off between unemployment and inflation that has been missing for many years may emerge again once the pandemic is finally over.