ECON430-Topic #4: Changes and Inflation Expectations

The Federal Reserve cares about what people think inflation will be in the future, and they are typically monitoring future expected inflation by various measures. A recent report by the Federal Reserve Bank of New York shows that the Fed’s Index of Common Inflation Expectations signals that that inflation expectations are remaining stable (if not drifting slower over time). A component of this inflation is measured by the Survey of Consumer Expectations showing some believe inflation is on the rise, expecting 3.1% over the next year. This one-year measure is higher than they have been in about seven years (see 2016 version of same report when they suddenly fell to 2.5% from 2.8%). While expectations based on this survey are up, the all time low measure was 2.5% in 2016, and the current value is down from levels when the survey first began in 2013.

In comparison, one-year inflation expectations, in the Atlanta Fed’s firm-level survey-based measure are rising, to most recently measure 2.4%, an increase over previous periods. The Cleveland Fed’s model of ten-year inflation expectations have recently just risen above 1.5% per year–an increase–but still much lower than the last few years.

One other measure of expected inflation compares the difference between returns on 10-year Treasury bonds and 10-year inflation-protected Treasuries (or TIPS). This measure–called the 10-year breakeven rate–has recently risen to 2.32%, the highest level since 2013. It suggests investors expect the U.S. inflation rate to be running at annualized 2.32% on average within a decade, slightly above the Fed’s 2% target.

The Federal Reserve itself offers a consensus forecast (2017 and more recent) based on measures put forth by the individual central banks. Looking at the graph and table above, you might notice that today’s inflation measures are still near 2%, but they have moved much higher than just in December 2020.

Recent measures of actual inflation for headline inflation are still actually below 2% for the start of 2021, and have not exceeded 2% since 2018. We have tended to now undershoot the Fed’s target for medium term inflation for many years now. There are many measures of inflation, and survey-based measures do give some insight on how these expectations are formed and used.

Fed research from St. Louis, suggests these inflation expectations are not all that accurate. Furthermore, the San Francisco Fed finds that market-based measures do not appear to offer much information about future inflation as one might expect. However, it should be noted that people probably make plans on their investments, and wage setting based on what they expect inflation to be. With that being said, it appears as though the Fed’s inflation expectations play a role in their future policy, as noted by former Fed Chair Ben Bernanke (if you are going to read one thing here, make it the Bernanke article).

Issues you might want to address:

  • Why do you think consumer expectations of inflation are so out of line with other measures of inflation expectations? Is there a secret plan by the Fed to manipulate inflation measures? Many people think so, but there might be a simpler reason. One can think of how inflation expectations are very slow moving, and therefore it is difficult to move expected inflation from its level.
  • How do you compare market and survey-based measures of expected inflation? Which ones have historically been more accurate if they have been accurate at all? What other information that is available in survey-based measures gives us any insight about how people plan for inflation in the future?
  • How do you think the Fed “thinks” about inflation expectations? Note that Janet Yellen and now Jerome Powell have mentioned that they believe inflation will meet it’s medium-term target of 2%, given market and survey based measures of expectations simply do not align with that.
  • Please feel free to address any other pertinent questions that are not specifically mentioned here, and feel free to bring in outside sources for help. Just make sure you are discussing one of three things. The official projections/forecasts of inflation, consumer/firm expectations of inflation, or market predictions of inflation.

16 thoughts on “ECON430-Topic #4: Changes and Inflation Expectations”

  1. As the global pandemic comes to an end, consumer inflation expectations rise to a seven year high of about 3.1%. Consumer expectations are a critical indicator of how actual inflation behaves. If people expect prices to rise, they will demand higher wages, rents will go up, and the overall price level will rise as well (1). In this way expectations may become a self-fulfilling prophecy. Though the Fed welcomes a slight rise in inflation, they are relying heavily on anchored expectations to hold inflation stable while unemployment falls, and the economy recovers (2).
    In recent decades, the Fed has managed to anchor expectations at about 2%, and inflation has not appeared to respond much to changes in economic indicators (3). For example, in recent decades price shocks in oil and energy sectors have not caused recessionary periods or higher inflation as they would have in prior decades. Certainly, price hikes for these goods will increase inflation in the short-term, but high inflation will not persist in the presence of well anchored expectations. This can be reflected in recent studies of the Phillips curve showing it has become flatter over the past thirty years (4).
    A CivicScience survey found that 77% of Americans are concerned about higher inflation, and recent increases in the price of oil only seems to confirm these fears (5). If recent history is any indicator, these shocks will not result in persistent inflation as the Fed predicts. Still, the Fed will have to work hard to ground rising expectations in order to prevent excessive inflation.


  2. Consumer expectations are a signal to the fed of what inflation will look like in the future. Inflation is largely is controlled by inflation expectations. For example, if consumers individuals expect costs to rise they will demand higher pay and landlords will increase rents, which will then push inflation higher. (1) The Fed looks to achieve maximum sustainable employment and price stability. They look for an average annual inflation rate of about 2 per cent. (2) The easiest way for the fed to do this is for them to use monetary tools. At the end of August 2020, the fed changed its monetary framework and decided that instead of sticking with a 2 per cent target rate it will now offset its periods of below 2 per cent inflation with periods above two per cent. (2) Consumers expect inflation to rise above its current trend over the next 10 years. However, consumers also perceive actual inflation to be higher than its official readings. Due to this analysts tend to focus on the trends of these surveys to see whether consumers expect the pace of inflation to be rising, falling or remain stable. There are various reasons why expectations are important, however, two stand out. The first is the inputs such as price and wage setting, and the second is they help assess the credibility of the central bank’s inflation objective. (3) Consumers have a very large impact on the inflations rate and how the central bank acts to keep this at their desired levels.




  3. Inflation expectations are hard to manage. Inflation expectations in the United states rose from 3.09% in February to 3.20% in March (1). This is despite the Fed’s repeated attempts to assure that rates will be low through 2023. Jerome Powell recently did an interview on 60 minutes at an attempt to anchor expectations. He again reassured that the Fed would set a low nominal anchor for rates through 2023. This however was an already stated policy of the Fed, so if the Fed were credible then why would they need to keep reassuring the public through open mouth policy. Consumers’ inflation expectations can reflect changes in the price of gas (2). Rising prices can create a cycle where they give the impression of inflation, so in responses consumers will spend more now, creating a self-fulfilling prophecy for prices to rise. Changes in prices can lay outside of the Fed’s reach. Fed can try to stir expectations all they want but if prices rise and the cycle begins, people may believe their eyes more than the credibility of the Fed. One way we can measure inflation expectations is market-based measures. Market-based measures are tied to the market for Treasury Inflation Protected securities or TIPS (3). Consider a nominal security and an inflation adjusted security with the same maturity. The price difference between the two can be interpreted as the market’s expectation of inflation. Market-based measures can be favored over survey-based measures because they tend to react to incoming economic information quicker than the survey-based measure. No matter which method is used for expected inflation, it has real psychological impacts that effect the real decisions people make. Can the Fed truly have the ability and credibility to wage this psychological battle.

  4. Expectations of inflation play a large role in actual inflation. It is almost like a self-fulfilling prophecy. Wages and prices are adjusted by firms based on what they expect inflation to be. Expectations of inflation are fluid and not entirely anchored. Consumer expected inflation is more inelastic than it used to be and as of the early 2000s it has mostly been stable. However, it has been stable at an imperfect level. This is because, in reality the rational expectations model does not hold. Market agents do not act with perfect information, because not only do they not have access to all information, but the information they do have is sometimes wrong. According to the fed expectations index expectations have experienced little variation and hover right around 2%. This is because the Fed’s inflation target is 2%. Fed Chairman Powel has stated that he wants inflation to rise above and remain above that 2% mark until 2023. As a result the median one-year ahead expected inflation rate, per a New York Fed survey, has jumped to 3.1%. Per that same survey, the median three-year expected inflation rate is slightly lower just below 3%. As the country gets vaccinated and starts reopening the Fed projects the economy to grow by 6.5% this year. This will be aided by the relatively high expected inflation causing real inflation which in turn should lead to more investment and less unemployment. This will prompt the Fed to lower inflation back down to the target 2%. This cycle is a large part of why the Fed expectations index has experienced so little variation over the past 20 years.,4.2%25%20it%20predicted%20in%20December.

  5. Consumer expectations of inflation greatly exceed what is being forecasted by the Fed, a sign both that consumers are not willing to take the Fed’s statements at face value, and that inflation is likely to increase over the next year. Consumer expectations have a large impact on actual inflation, since expected increases in price will lead to a higher demand for wages, creating a sort of self-fulfilling prophecy (1). So, these consumer expectations should be a sign that inflation is likely to trend higher than the target rate of 2%, yet figures within the Fed such as Jerome Powell maintain that they expect inflation to be at the 2% target value in the “medium-term.” There are a couple of potential causes for why he would be making this statement. One is that there is genuine belief that the economy is headed to sustained 2% inflation, likely stemming from that being the inflation rate in 2020 (2). This also seems logical given that, although there were massive amounts of expansionary monetary policy in 2020, inflation had still been trending upwards before the pandemic and subsequent intervention (2). The other explanation for why the Fed would be publicly stating they expect a 2% rate though is that they are attempting to use their forecasts as a means of driving down inflation expectations, in an attempt to keep actual inflation at the 2% level. From an analysis of bond rates however, it seems that investors believe inflation will increase over the next five years and then lower back to normal rates after (3). This implies the former is more likely, that the Fed shares confidence that over the medium-term rates will truly be around 2%.



  6. Inflation expectations can be determined using two measures: market-based inflation expectations, and survey-based inflation expectations. Market-based predictions are based on the prices of financial securities and include TIPS breakeven inflation rates and inflation swap rates (2), while survey-based predictions are the results of questionnaires sent to renowned economists (1). Previous studies have shown that historically, survey-based expectations have been the best performing method for predicting inflation (3). Other research suggests that another benefit of survey-based measures is that they include the people’s understanding of monetary policy (4).
    Past studies have compared these two methods of predicting short-term inflation rates by comparing forecasting errors for both one and two years in the future, in addition to utilizing the Diebold-Mariano test to test for significant differences in their performances (1). Another study found that the best time series model to compare the methods is a simple ARMA(1,1) model, which is an “autoregressive moving average model” with constant coefficients. However, that same study found that survey-based predictions outperform both ARMA (1,1) and Phillips’s curve-based models when it comes to measuring CPI (3).


  7. I think the overly extreme inflation expectations from consumers come from a variety of places. The first being the stimulus checks that are being pumped into our economy. When non-economic minded individuals think of inflation, they think about dollar losing its value which to an extent is true. So, when there are more dollars being pumped into our economy people think that the dollar’s value is going to decline which to their perception is the case with stimulus checks.
    Alongside this, there has been a surge in the amount of money invested in the stock market. The cause of this could be because current investors are now dumping more money into stocks while they are low, and/or new investors are taking their new endowment from the government and trying to earn a return on it. In fact, $569 billion was invested in stocks over the past 5 months while only $452 billion was invested in the past 12 years! Never-the-less this is causing there to be higher returns than would typically see. The S&P gained more than 16 percent with the Dow and Nasdaq finished at record highs both being seen in 2020. With greater returns and more people investing in this opportunity to earn more money, people may be changing their outlook of inflation now that they are seeing higher returns on their assets.
    With this greater income stream and people spending more time working from home, the housing market has been booming during the COVID crisis as well. Individuals are upgrading their living standards, which may be due to individuals moving to places they previously couldn’t because of ties to commutes to work. For this reason, turnaround times for buying and selling homes are extremely rapid and homes are selling for prices way higher than they are appraised for. The median home sale price is up 16% and 39% of homes sold above their listing price during the four-week period ending this past March.
    I believe that the perception to consumers of money appearing to be created out of thin air and increases in markets that would typically persist in a booming economy is what is most likely what is causing inflation expectations to be so extreme.

  8. Bonds are fixed income products, and the future cash flow is certain and will not increase. Therefore, under the expectation of inflation, people all hope that their assets can appreciate with inflation, to maintain their purchasing power (keep the real interest rate unchanged). Therefore, the future cash flow (fixed income) products will be unattractive, so the demand for bonds decreases. Behind the underlying logic, is the real interest rate (purchasing power) fall in inflation expectations
    If under the premise that the Keynesian liquidity preference theory, only monetary and bonds, increase the money supply at this time, expected inflation rate rise, bond prices will fall, a capital loss, and people are willing to hold money, money demand to increase. If the expected inflation increased, people will be in the current money into physical, money demand current will be reduced
    Expected prices rise, money is not valuable, that is to say to inflation, if you don’t reduce the demand for money, will increase inflation, economic rapid development, exceeds the limits of the economic system can bear, will break down economic system
    In other words, with inflation, consumers are spending more rationally in certain areas, such as some consumables… On the other hand, due to inflation, most people must now shift their money into more stable assets, real estate, etc. Both cause a decrease in the demand for money in circulation
    “The fed officials worry that, for failing to achieve the inflation target, as time goes on the market confidence in the fed could weaken, which may lead to consumer and enterprise future inflation is expected to reduce, leading to price pressure weakened further
    “In the short term, any change is likely to tilt policy in the direction of keeping interest rates low for the longer term, and thus to keep inflation more stable at an average of 2 percent.
    The Fed is now using low inflation as an excuse to cut interest rates.
    FOMC changed the wording in the policy statement on May 1, 2019, stressing that the inflation rate was lower than previously expected and did not reach the target of 2%. Through a large number of articles, published in the past two-week mainstream media seem to be more sufficient to confirm speculation: the fed is hope, people believed that, at this stage need more inflation in the United States. And through the media, can let the fed to evaluate market reactions to new ideas, and let the market and the public to be prepared for the policy of potential changes.
    Someone raises a question: inflation is a legitimate concern, or is it just a cover for the fed’s rate cut to provide false signals?
    In the federal reserve to create inflation measures, reduced the price of all goods and services in the CPI and the GDP report temporary fluctuations. The fed thinks, this statistical model more reference value and sustainability, not like other inflation forecast model is affected by the temporary factors too. In the measure of the federal reserve, less than expected inflation is a big potential threat to the economic development of the United States.


  9. Consumer expectations are one of the biggest indicators of what the inflation rate will end up doing because it changes the way the public handles their consumption. Expected inflation and actual inflation rate go hand in hand when seeing a shift. According to a recent survey done by the Federal Reserve Bank of New York consumer expectations has increased from 3.1% last month to 3.2%, this is the highest level it has reached since 2014 (1). This drastic rise in predicted inflation could be due to the surge in prices this past March. The acceleration in prices was the fastest they have risen nine years which is an understandable reason for expected inflation to be at the rate it is at now (2).
    Despite the consumers expectation the Fed thinks otherwise. When asked about predicted inflation this year Fed Chairman Jerome Powell stated that inflation is on track to moderately exceed the desired 2% (3). Originally the Fed had estimated that there would be a 1.8% increase this year but they have now changed this prediction to 2.4% which is still down from consumer expectations (4).
    The Fed has recently rolled out a new plan when dealing with inflation which is aimed at creating a booming job market without surging inflation (5). Now instead of trying to anchor the inflation level at 2% the Fed has announced that they will be targeting an average rate of 2% (5). This means that the Fed will now be seeking inflation rates above 2% to offset rates that go below it.


  10. Despite the tendency for the US economy to fall short of the Fed’s 2% target inflation rate for quite some time; consumers have continued to overestimate expected inflation by as much as double (1). There have been several compelling arguments put forward as to why the market falls short of the Fed target, and why the consumer expectation is so far out of line, often by as much as a whole percentage point (2). Some have argued that consumers as a whole always overestimate inflation and that this gap is perhaps the result of a pessimistic human nature to fear negative outcomes, as inflation is generally understood as a “bad outcome” (3). Despite the warning calls present in the media and some popular economists since the start of quantitative easing during the Great Recession, the American economy has not experienced the inflation expected by consumers and the market 10-year breakeven rate to a lesser extent (4).

    Some have made the case that the Fed is secretly manipulating inflation measures in order to achieve some end, but it would not seem that the Fed truthfully has the power to do so. While inflation expectations may remain stable and constant in the near term, evidence suggests that long-run inflation expectations are not perfectly stable or anchored to a stated Fed target (5). While consumer inflation expectations have long overshot the 2% Fed goal; they are often extremely volatile throughout recessionary periods, namely at the beginning of the recession and towards the end, despite the Fed’s commitment (even to an extent now) to a 2% target rate (6). Even as high-profile FOMC members have continued to echo to the public their higher-than-target inflation and growth forecasts, evidence suggests that these statements have no significant impact on the 10-year breakeven rate, thus no impact on long-run inflation expectations (7). I challenge the notion that the Fed is secretly manipulating inflation measures when the consumer survey inflation expectation rates and breakeven rates reflect the likelihood that the Fed’s forecast messaging has little to no efficacy.


  11. Consumer’s expectations about inflation are out of line with other measures of expected inflation as consumers pay more attention to items they frequently purchase compared to those that they purchase less frequently. Since inflation is measured across a broad spectrum of goods, consumers notice changes to price in items that they purchase more often. During the COVID pandemic, airfares were down 27% while prices for food at home were up 5.6% from the year prior (1). Since consumers do not purchase air tickets as frequently, they would not notice a change in prices as quickly as they would for food. An individual’s expectations about inflation are closely related to the changes they observe in prices. Those that experience greater changes in price are more likely to have higher expectations of inflation in the future (2). Since expectations are slow moving and consumers base their expectations about prices they are currently facing, their expectations will deviate from other measures of inflation expectations that consider a broader range of goods and their prices.
    Once a consumer has an expectation about future inflation, it is difficult to change. Since their expectation is about prices they observe more frequently, it is difficult to change their expectation. Without taking into account the price changes of various goods such as airfare and food, their expectations can be skewed in one direction. To change this expectation, the consumer would have to notice changes in price of other goods, typically of those that are less frequently purchased. Since they do not observe the price of these goods often, noticing changes in prices can be difficult without complete prior knowledge about the price. As a result, changing consumers’ expectations about inflation can take a long period of time since their expectations are developed through observed changes in frequently purchased goods.


  12. In analyzing consumer inflation expectations, a study done by the European Central Bank found that consumers with higher inflation expectations are young females with low levels of formal education and belong to lower income groups (1). On the other hand, consumers who say they are in a better financial situation tend to have lower inflation expectations. Although this isn’t in the United States, it is interesting to examine what the implications of different expectations have on monetary policy. The Cleveland Fed, in a similar study, concluded that knowing the expectations that align with different demographic groups helps the Fed understand why there is a difference in savings among groups (2). It may be valuable for monetary policy makers to know the breakdown of expectations by demographic to better understand when and why consumers make the choices they make. This knowledge of demographics has the potential to help inform the Fed on what policies work for particular groups and what policies do not.
    The New York Fed has also researched the impact of demographics on inflation expectations overtime. They found that in the United States, Black, Hispanic, low income and less educated women tend to be slower in changing expectations overtime (3). This finding is significant because it has the potential to explain why this particular demographic has a larger error gap in inflation expectations compared to other groups.
    A suggestion that I would have to help different demographic groups understand the future of inflation better would be an increase in financial literacy. A common theme in these papers discussing demographics is that people with lower levels of formal education tend to be further off when making a decision about inflation, which is understandable. However, with an increase in financial literacy at any stage in life, the Fed could make better monetary policy changes when the people affected by them understand the decisions.


    2. The Demographics of Inflation Opinion Surveys: Cleveland Fed, October 15, 2001, PDF


  13. It seems as though experts are unsure to whether inflation will increase post COVID-19 or continue to stay low due to the sheer amount of damage the pandemic wreaked on the economy. On one hand, as lockdowns are lifted consumers will begin to rapidly spend and this sudden increase in economic growth will cause massive jumps in inflation. On the other hand, post-lockdowns, businesses would still open up but consumer’s ability to spend has been dampened by the pandemic (1). Many people lost their savings, homes, or livelihoods during the pandemic, and due to this will not suddenly jolt into action. Rather, individuals will try and save and try and get their heads above water before cautiously spending. In a more pessimistic view, consumers simply will not be able to spend, lost incomes and lost assets will force consumers into a position where they can only spend on the bare necessities (2).
    As states begin to open up, there have been little reflection on the monthly updates to the urban CPI. According to data collected by the St. Louis Branch of the Federal Reserve, the Consumer Price Index has increased, but it only to re-conform into the original trend line the US has been seeing since the early 1980s (3).

  14. With the end of this pandemic hopefully on the horizon and the warmer weather coming in, this will likely lead to an increase in the inflation rates. This will be caused by consumers purchasing goods and services. I think this will happen because with Spring weather arriving makes people want to go out and spend their hard earned money they have been holding onto since the beginning of the pandemic. Another reason that will cause the inflation rate to also increase is the fact that consumers have not been able to spend their money as they usually would doing the colder months with the global pandemic going on. Hopefully we are seeing the last days of COVID-19 and things will get to a somewhat normal level. With these people spending their money the demand for goods will increase which in-turn will cause the price of said good to increase. With the price of goods increasing this will cause the inflation rates to also increase. I think this is why consumer expectations of inflation are so out of line.

  15. Inflation expectations has been a point of concern for many observers and commentators in recent months as the US and world economy starts to recover from the 2020 pandemic. Yet, over the last several years, consumer expectations of inflations have failed to match that of many expert forecasts and modeling, which poses the question as to whether or this is the actual underlying goal of the Federal Reserve. As many would like to believe this to be true, the reality is that measure used by market observers and professionals often is not based on the real economic situation of many consumers in the wider economy.

    The Federal Reserve has been criticized in recently years for failing to meet its set inflation target of two percent in the medium term, but in recent years many have failed to appreciate the ability consumers have in purchasing goods from markets around the world—with little friction. This has allowed consumer goods to remain stable, even as interest rates remained at historic lows since the 2008 financial crisis.

    As long this unprecedented access to good and services remains available to consumers in the US via retailers like Amazon and Walmart, inflation will continue to underperform even with the possible passage of multi-trillion fiscal stimulus currently being debated in Congress.

  16. Current treasury secretary Janet Yellen’s 2007 speech(1) regarding behavioral economics, while her time as Fed chair, underpins the fact that the Fed, along with modern economists, are increasingly interested in human’s innate financial behaviors and preferences. Such attentiveness to a specific field of study outside of macroeconomics comes as historically captivating models within the area, most notably the Phillips curve, are increasingly appearing to behave in a manner that contradicts Philip’s initial assertion. Such a dramatic change within the field has prompted the Fed to increasingly try to mold individuals’ future expectations and, more generally, better understand consumers’ thought processes to try and incorporate it in their monetary policy decisions, usually through forward guidance. As in last week’s 60 Minutes(2) interview with Fed Chair Powell, it is just another approach to how the Fed tries to mold our expectations. But when the Fed Chair “pledges” to keep rates low through 2023(3) yet contradicts his statement on 60 minutes by saying rates will increase if inflation goes above 2% as it likely will well before 2023, the Fed’s forward guidance becomes counterproductive as well as hinges on their credibility.




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