At the intersection of monetary policy and behavioral economics, this book develops the concept of defensive expectations. It argues that, following an income loss, households increase savings to compensate for that loss. As a result, inflation remains subdued until the income loss (measured by the cumulative wage gap relative to a past peak) has been fully recovered, after which inflationary pressures begin to emerge. The cumulative wage gap is a better measure of slack in the Phillips Curve than either the output gap or the unemployment gap.Offering a rigorous and original account of both persistently low inflation and the sharp inflationary episodes that followed the COVID-19 pandemic, this volume will be of particular interest to policymakers, central bankers, economists, and scholars of macroeconomics and behavioral economics. It will also appeal to readers seeking a more nuanced understanding of the links between inflation, saving, consumption, and recessions.
