## How Managing Inflation Expectations Can Help Economies Achieve a Softer Landing

_IMF Blog, October 4, 2023_

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## Bibliographic details
- Authors: Silvia Albrizio, John Bluedorn
- Published: October 4, 2023

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### Overview
- Inflation reached multi-decade highs last year; headline inflation is coming down steadily, while core measures and wage growth have picked up.
- Expectations about future inflation influence consumption and investment decisions and therefore affect prices and wages today.
- The blog summarizes findings from Chapter 2 of the October 2023 World Economic Outlook, “Managing Expectations: Inflation and Monetary Policy.”

### Larger role for inflation expectations
- Near-term expectations (for inflation over the next 12 months) rose steadily starting in 2021 and accelerated last year as actual price increases gained momentum.
- Expectations for inflation five years into the future remained stable, with average levels broadly anchored around central bank targets.
- Near-term inflation expectations have recently begun a gradual downward path.
- Similar patterns of inflation expectations are observed across professional forecasters, companies, individuals, and financial-market investors, on average.

### Empirical findings on expectations and inflation dynamics
- After the inflationary shocks in 2021 and early 2022 began unwinding late last year, inflation has been increasingly explained by near-term expectations.
- For the average advanced economy, near-term expectations now represent the primary driver of inflation dynamics.
- For the average emerging market economy, expectations have grown in importance, but past inflation remains more relevant.
- Quantitative pass-through estimates:
  - In advanced economies, inflation typically rises by about 0.8 percentage points for each 1 percentage point rise in near-term expectations.
  - In emerging market economies, the pass-through is 0.4 percentage points for each 1 percentage point rise in near-term expectations.

### Differences in learning and their consequences
- Two learning types:
  - Backward-looking learners: form expectations based on current or past inflation experiences, especially when information on inflation prospects is scarce or central bank communications lack credibility.
  - Forward-looking learners: form expectations using a broader array of information relevant to future economic conditions, including central bank actions and communications.
- Economies with a higher share of backward-looking learners tend to be those with historically higher and more volatile inflationary experience.
- Policy consequence: when more people are backward-looking learners, policy tightening has less dampening effect on near-term inflation expectations and inflation, so central banks must tighten more to achieve the same decrease in inflation.
- Resulting trade-off: reductions in inflation expectations and inflation come at a higher cost to output when a higher share of backward-looking learners is present.

### Model simulations and policy implications
- A new model allowing for differences in learning and expectations formation shows:
  - Policy tightening is less effective at reducing near-term expectations and inflation when backward-looking learners are more prevalent.
  - Improvements in monetary policy frameworks and communications can lower the output costs needed to reduce inflation and inflation expectations.
  - Such improvements increase the likelihood that a central bank can achieve a “soft landing” (guiding inflation back to its target without causing a deep downturn in growth and employment).

### Policy recommendations and communication strategies
- Strengthen monetary policy frameworks to increase independence, transparency, and credibility of monetary policy.
- Communicate more clearly and effectively to encourage forward-looking expectations formation.
- Use simple and repeated messaging about objectives and actions, tailored to relevant audiences.
- Recognize that improving frameworks and communications can take time or be difficult to implement; these efforts are complementary to traditional monetary policy tightening, which remains key to returning inflation to target in a timely manner.

*This blog is based on Chapter 2 of the October 2023 World Economic Outlook, “Managing Expectations: Inflation and Monetary Policy.” The authors of the report are Silvia Albrizio (co-lead), John Bluedorn (co-lead), Allan Dizioli, Christoffer Koch, and Philippe Wingender, with support from Yaniv Cohen, Pedro Simon, and Isaac Warren.*

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## References

- [analytical chapter of the latest World Economic Outlook](https://www.imf.org/en/Publications/WEO/Issues/2023/10/10/world-economic-outlook-october-2023?cid=bl-com-AM2023-WEOEA2023002)

_Source: https://www.imf.org/en/blogs/articles/2023/10/04/how-managing-inflation-expectations-can-help-economies-achieve-a-softer-landing_