۱- Introduction

۲- Characteristics and determinants of inflation expectations

۳- Do inflation expectations affect economic decisions?

۴- Measuring inflation expectations

۵- Breaking through the veil of inattention

۶- Conclusion

References

Abstract

We assess the prospects for central banks using inflation expectations as a policy tool for stabilization purposes. We review recent work on how expectations of agents are formed and how they affect their economic decisions. Empirical evidence suggests that inflation expectations of households and firms affect their actions but the underlying mechanisms remain unclear, especially for firms. Two additional limitations prevent policy-makers from being able to actively manage inflation expectations. First, available surveys of firms’ expectations are systematically deficient, which can only be addressed through the creation of large, nationally representative surveys of firms. Second, neither households’ nor firms’ expectations respond much to monetary policy announcements in low-inflation environments. We provide suggestions for how monetary policy-makers could pierce this veil of inattention through new communication strategies as well as the potential pitfalls to trying to do so.

Introduction

Policy-makers have long understood the importance of communication strategies and the management of economic expectations. Since the early 1990s, central banks have become increasingly open in discussing their actions, objectives and views about the economy. This shift was motivated by the idea that clear communication can help reduce financial and economic volatility in response to central banks’ decisions as well as augment the tool set of monetary policy (Blinder et al. 2008). For example, statements about the expected path of future short-term interest rates can affect contemporaneous long-term interest rates and therefore influence current economic conditions even in the absence of any immediate policy change. The onset of the Great Recession and the constraints imposed by the zero-lower-bound (ZLB) on interest rates have brought these less-traditional tools to the forefront of policy-making. Along with quantitative easing policies, forward-guidance about the path of future interest rates has become one of the primary tools through which central bankers try to affect economic outcomes. Discussion has also focused on alternative policies that can affect the economy contemporaneously through expectational channels, such as raising the inflation target or adopting nominal-GDP/price-level targets. At the heart of these policies lies a mechanism hinging on the inflation expectations of agents: convincing them that inflation will be higher in the future should, in the absence of interest rate policy offsets due to the zero bound, lower their perceptions of current real interest rates and therefore induce households and firms to increase their spending today. Higher expected inflation can also lead firms to immediately raise their prices in anticipation of rapidly declining relative prices, and workers may similarly bargain for larger nominal wage increases. Thus, policies directly impacting agents’ inflation expectations can be used to stabilize economic conditions when traditional policy tools are limited.