Inflation Expectations
Finding the best way to inform people about future prices is vital; because rising prices will exacerbate public concern about inflation and make it a more ingrained issue. A section of the World Economic Outlook report published by the IMF in October 2023 discusses the impact of expectations on inflation. This report also examines the monetary policy framework in guiding expectations and achieving a soft landing without causing a deep recession in growth and employment.
The Profound Impact of Inflation Expectations
Future research indicates that inflation expectations have been rising steadily since 2021 in both advanced and emerging economies. With the surge in inflation last year, these expectations have also accelerated. However, long-term inflation expectations have remained anchored around central bank targets. Recent studies suggest that short-term inflation expectations have begun to gradually decline. Apart from the views of future researchers, on average, similar patterns of inflation expectations are observed among businesses, individuals, and financial market investors.
Changes in short-term expectations are economically significant for inflation dynamics. According to IMF data, following the inflationary shocks of 2021 and 2022, the inflation rate was well-explained by short-term expectations. Inflation expectations are now a key driver of inflation dynamics in advanced economies. In developing economies, these expectations have become more important, though past inflation still holds greater relevance, indicating a retrospective outlook among people in these economies. This may reflect their higher and more volatile inflationary experiences.
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In fact, IMF data shows that in advanced economies, for each one percent increase in short-term expectations, inflation increases by about 0.8 percentage points, whereas in developing economies, this rate is 0.4 percentage points. The report categorizes individuals into forward-looking and backward-looking learners, explaining the difference between advanced and developing economies. When information about inflation outlooks is scarce and central bank communications are unclear or lack credibility, people tend to base their future inflation views on current or past inflation experiences, making them backward-looking learners. Conversely, forward-looking individuals form their expectations based on a broader set of future-relevant information.
Policy Implications Based on Learning Differences
These differences have significant implications for central banks. Research shows that when a larger share of the population are backward-looking learners, tightening monetary policy will have less impact on short-term inflation expectations and the inflation rate. This is because backward-looking individuals do not consider how reducing interest rates today will lower inflation through its impact on demand. In societies with more backward-looking individuals, the central bank needs to apply more pressure to achieve its inflation targets. Moreover, inflation-containment policies in these societies will have higher associated costs.
Enhancing the Effectiveness of Central Bank Policies Central banks can encourage forward-looking behavior by improving the independence, transparency, and credibility of monetary policies and establishing clearer and more effective communication with the public. These actions can help people understand central bank policies and their economic effects, increasing the number of forward-looking learners. Simulations in this research indicate significant impacts of improving the monetary policy framework and communication on reducing policy implementation costs. These actions can help central banks achieve a soft landing. One way to enhance central bank communication is by sending simple and frequent messages about their goals and actions. However, improving the monetary policy framework and creating new communication strategies to support inflation dynamics may be time-consuming or challenging to implement. Such interventions complement traditional and stricter monetary policies, which play a crucial role in timely inflation control.
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2 个月Thank you Mehdi for this informative post. Core inflation as you describe here, is measured in America, from three subsidized markets in energy, transportation and agriculture. When we stabilize prices through subsidy, we stabilize our metrics and we stabilize our markets. Inflation, world-wide, has been the creation of a United States of American policy to destabilize an entire world economy through runaway price increases in plant, equipment, land, homes, cars and more. In America, President Nixon in 1971 took us off the gold standard. As a result we've seen a doubling in prices every seven years. However, you would never know this, as you are completely unaware. A home, a car in America in 1971 cost $14,000 & $1,200 respectively. Today that home, that car costs $1.5 Million and $60,000. What does that mean for the family, our local and federal governments, corporations, family businesses? Debt is the result, for our businesses, for our multinational's, for our local and federal governments,... And now we place the dagger into the back of our economy as we raise interest rates.... through a private... banking group, run by men who are both unelected & appointed. MARK applied physics