Inflation Expectations in Australia

• Published date: 01 March 2022
• Author: Benjamin Beckers,Anthony Brassil
• Date: 01 March 2022
• DOI: http://doi.org/10.1111/1467-8462.12457

The Australian Economic Review, vol. 55, no. 1, pp. 125–135DOI: 10.1111/1467-8462.12457

Inflation Expectations in Australia

Benjamin Beckers and Anthony Brassil*

Abstract

Inflation expectations are typically considered a

pivotal and causal driver of inflation dynamics

over which central banks have a strong influence.

Given this influence, it is important for central

banks to understand how expectations are

formed and how their operations influence these

expectations. We describe the various ways

inflation expectations are measured and used

by the Reserve Bank of Australia (RBA), and then

review the evidence on how Australians form

their expectations. In contrast to what is assumed

in standard macroeconomic models, expectations

are generally not formed rationally or with full

information. We close by highlighting what these

findings imply for the conduct of monetary policy.

1. Why are Inflation Expectations

Important to Understand?

Inflation expectations feature in basically every

modern model of how the macroeconomy works.

And it is the ability of central banks to influence

these expectations—via their credible pursuit of

inflation targeting—that is widely credited for

moving the world from the Great Inflation of the

1960s and 1970s to the Great Moderation of the

1980s and 1990s (Bernanke 2004; Bordo and

Orphanides 2013).

Inflation expectations are thought to play an

important role in wage‐and price‐setting. For

instance, workers want to maintain the real

purchasing power of their labour income, and

will therefore bargain for higher nominal wages

if they expect higher inflation (Blanchard 1986).

Similarly, firms want to maintain their profit

margins, and will therefore increase prices if they

expect higher nominal input costs. This interac-

tion between wage‐setting, price‐setting and

inflation expectations can lead to some destruc-

tive economic dynamics, such as wage‒price

inflationary spirals.

If all prices are completely flexible, these

relationships between expectations and prices

need not have any ‘real’effects (Galí 2015). But

in the presence of nominal frictions—as captured

in New Keynesian DSGE models—changes in

expectations cause changes in both real and

nominal variables and can therefore lead to

reductions in welfare. In an extreme example,

runaway expectations could lead to hyperinflation

(Sargent and Wallace 1973). And if expectations

are self‐fulfilling (i.e., changes in expectations

cause future price changes that validate the

* The Reserve Bank of Australia, Sydney 2000, Australia;

Corresponding author: Brassil, Email: brassila@rba.-

gov.au. We would like to thank Tomas Cokis, Ann

Collins and Stephen Cupper for data and research

assistance, and James Bishop, Tomas Cokis, Luci Ellis

and John Simon for valuable comments. The views

expressed in this paper are those of the authors and do not

necessarily reflect the views of the Reserve Bank of

Australia.

The Work has been produced by Reserve Bank of

Australia staff in the course of their employment or

engagement by the Reserve Bank of Australia. However,

the views expressed in this version of the work do not

necessarily represent the views of the Reserve Bank of

Australia. The Reserve Bank of Australia does not give

any warranty nor accept any liability in relation to the

contents of this work.

© 2022 Reserve Bank of Australia

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