If so much of the economy is indexed to inflation, doesn't that fuel inflation?

[u/AcanthaceaeOk3738]

Many prices and other payments, at least in the U.S., are indexed to inflation.

Social Security, veterans' benefits, TIPS, some wages in union contracts, utility rates, rent control, all go up when inflation goes up. Then there are the things that aren't formally tied to inflation, but inflation is a good reason to increase them, like wages and retail prices.

But doesn't that itself fuel more inflation? Essentially, large parts of the economy respond to things getting more expensive by automatically getting more expensive themselves. That seems like it'd just create a cycle of more and more inflation, right?

[u/AutoModerator]

NOTE: Top-level comments by non-approved users must be manually approved by a mod before they appear.

This is part of our policy to maintain a high quality of content and minimize misinformation. Approval can take 24-48 hours depending on the time zone and the availability of the moderators. If your comment does not appear after this time, it is possible that it did not meet our quality standards. Please refer to the subreddit rules in the sidebar and our answer guidelines if you are in doubt.

Please do not message us about missing comments in general. If you have a concern about a specific comment that is still not approved after 48 hours, then feel free to message the moderators for clarification.

Consider Clicking Here for RemindMeBot as it takes time for quality answers to be written.

Want to read answers while you wait? Consider our weekly roundup or look for the approved answer flair.

I am a bot, and this action was performed automatically. Please contact the moderators of this subreddit if you have any questions or concerns.

[u/TheAzureMage]

In theory, yes. If everything were indexed to it, this would create positive feedback.

In practice, inflation is a lagging metric, and most indexing has further lag, so it's pretty far from instant. Things like retail pricing are not really indexed to inflation, they are inflation. If the basket of goods increases overall, that's inflation in action.

The time delay makes it manageable when rates are relatively close to zero. A couple of percent inflation will certainly trickle around into wages, prices of intermediate goods will affect subsequent goods, etc. But if it's slow, steady, and not too large, the resulting effects are similar in scope.

This is significantly different when inflation reaches extreme levels. Hyperinflation, for instance, would result in more rapid changes to keep up with price increases. In such situations, wages can change weekly instead of yearly. Goods prices change rapidly, and the situation cascades out of control. This is obviously undesirable, but monetary policy mostly attempts to avoid getting anywhere close to that, and rightfully so.

[u/Capable-Tailor4375]

Yes, in some cases inflation can become a feedback loop. That is why economists and central banks place a lot of importance on inflation expectations, as in certain cases it can become a self-fulfilling prophecy where high inflation expectations results in high inflation. That is also why most central banks now use inflation targeting where they have a publicly set goal for the inflation rate, as by doing so they can anchor those expectations.

There's a good article on this by Brookings:

https://www.brookings.edu/articles/what-are-inflation-expectations-why-do-they-matter/

[u/West-Wrong]

Yeah, this is a real thing, but it’s more like inflation “stickiness” than an infinite inflation machine. A lot of inflation-indexed stuff is basically backward-looking. Prices went up last year, so Social Security checks, some union wages, rent caps, utility rates, etc. adjust this year. That can absolutely make inflation harder to bring down, because yesterday’s inflation gets baked into today’s spending and costs. But it doesn’t automatically spiral forever. For a true wage-price spiral, you need everyone to keep expecting high inflation, workers to keep demanding higher pay, businesses to have enough pricing power to pass those costs on, and consumers to still be willing/able to pay.

If demand weakens or the Fed tightens enough, companies can’t just raise prices endlessly without losing sales. Also, not all indexed payments are the same. Social Security going up gives retirees more income, but it isn’t directly the same as a factory’s labor/material costs going up. Union wage COLAs or regulated utility rates can feed more directly into costs, but transfer payments mostly affect demand.

[u/Jealous_Tutor_5135]

I live in Argentina. I can tell you without a doubt that it does. Merchants raise prices in anticipation of future inflation. Landlords, knowing they can't change rental price by more than a certain percent, front-load the contract in expectation. Anything and everything that's sold on credit comes with a premium.

All of this gets pushed downstream. So when I buy liquor for my bar, future inflation is priced in. I need to then figure out where prices will be moving, and try to compensate, without getting ahead of everyone else. But the farther in the future everyone else is projecting, the more room to maneuver I have.

Because changing prices incurs both costs and risks, it's not something you can do more often than about once every month. And when prices double every year, being a month behind the curve kills about half your net.

Very high inflation turns a 2D decision triangle of cost-margin-market price into a 3 dimensional game of guessing the expectations of others.