What's Up with Inflation Expectations?

• Published date: 01 March 2022
• Author: James Yetman
• Date: 01 March 2022
• DOI: http://doi.org/10.1111/1467-8462.12456

The Australian Economic Review, vol. 55, no. 1, pp. 136–140DOI: 10.1111/1467-8462.12456

What's Up with Inflation Expectations?

James Yetman*

1. Why Inflation Expectations Matter

Inflation expectations are the beliefs of

future price increases on which agents base

their economic decisions. These are impor-

tant, especially to central banks, for three

reasons. First, most central banks target a

low and stable inflation rate, often via an

explicit inflation target. Inflation expecta-

tions thus provide a means to evaluate the

credibility of the central bank. If monetary

policy is credible, then inflation expectations

should be expected to converge to the

inflation target as the forecast horizon

increases and expected inflation outcomes

are increasingly reflective of expected future

central bank actions (rather than current

shocks). Second, expected inflation is itself

asourceofinflationary pressure that may be

reflected in wage bargaining and price

setting decisions, and hence provides an

inputintomonetarypolicydecisions.The

expectations‐augmented Phillips curve em-

bodies this principle.

1

Third, expected infla-

tion rates, together with nominal interest

rates, determine expected real interest rates.

Thesehaveasignificant impact on savings

and investment decisions, important drivers

of the business cycle.

It is convenient to think of inflation

expectations as a single measure that is

common to all agents in the economy, and

across different forecasting horizons.

However, in reality there is a distribution of

expectations, both across agents and over

time. The entire distribution of expectations

contains important information. Further, dif-

ferent measures are more appropriate for

different purposes, including for each of the

three listed above.

In the next section, we will outline

different measures of inflation expectations,

and their relative strengths and weaknesses.

We then discuss the implications of these

measures at the current juncture: a period

with heightened uncertainty about future

inflation developments.

2. Whose Expectations?

There are two broad categories of inflation

expectations: those based on surveys and

those derived from financial market variables.

We focus on each in turn.

2.1Survey Measures of Inflation Expectations

Two types of surveys are commonly used to

produce expectations of inflation. These are

surveys of the expectations of economic

agents and the published forecasts of profes-

sional forecasters.

2.1.1Surveys of Economic Agents

In most economies, there are surveys focused

on different types of economic agents, asking

their views of future inflation. These can

include those of households, firms and even

labour union organisations.

In principle, expectations from household

surveys sound compelling: these should

capture the views of a broad cross‐section of

the members of society, in effect subsuming

other, more specialised, samples. For a central

bank seeking confirmation that a stated

inflation objective is widely understood and

* Representative Office for Asia and the Pacific, Bank for

International Settlements (BIS); email <james.yetman@

bis.org>. The views expressed here are those of the

author and are not necessarily shared by the BIS.

© 2022 The University of Melbourne, Melbourne Institute: Applied Economic & Social Research, Faculty of Business

and Economics

Published by John Wiley & Sons Australia, Ltd