{ "title": "The Role of Inflation Expectations in Monetary Policy", "publication": "IMF News, May 15, 2023", "sourceUrl": "https://www.imf.org/en/news/articles/2023/05/15/sp-role-inflation-expectations-monetary-policy-tobias-adrian", "canonical": "https://www.imf.org/en/news/articles/2023/05/15/sp-role-inflation-expectations-monetary-policy-tobias-adrian", "overlayPath": "/en/news/articles/2023/05/15/sp-role-inflation-expectations-monetary-policy-tobias-adrian/index.md", "summary": "Inflation expectations are an important factor in monetary policy decisions. And with actual inflation far off target in many countries around the world, there has been an increased focus on inflation expectations and whether they remain anchored.", "publishDate": "2023-05-15", "sections": [ { "heading": "Overview", "content": "- Topic: Which inflation expectations matter for policymaking (forecasters, markets, households) and across horizons (near-term vs longer-term).\n- Context: Actual inflation is \"far off target in many countries around the world,\" increasing focus on whether inflation expectations remain anchored.\n- Remarks: IBF / Deutsche Bundesbank Symposium — Remarks by Tobias Adrian, IMF Financial Counsellor and Director of the Monetary and Capital Markets Department, May 15, 2023." }, { "heading": "Historical role of inflation expectations", "content": "- Early Phillips curve frameworks omitted expectations; Samuelson and Solow (1960) introduced a modified price-inflation Phillips curve implying a trade-off policymakers could exploit.\n- Empirical breakdown in the mid-1960s and The Great Inflation (1970s–early 1980s) led to recognition of supply shocks and stagflation (Gordon 1975; Blinder, 2022).\n- Phelps and Friedman emphasized the role of inflation expectations: deviations from the natural rate of unemployment shift the short-run Phillips curve; unemployment below the natural rate increases inflation expectations, shifting the curve up.\n- By the Volcker era, long-run inflation expectations became a central focus; long-term bond yields (assumed minus risk premia) were used as imperfect proxies.\n- Observed long-term nominal yields rose from \"roughly 4 percent in the early-1960s to nearly 20 percent by the late-1970s,\" interpreted as de-anchoring and a symptom of low central bank credibility.\n- Volcker disinflation experience: observed inflation fell more quickly than long-run expectations (proxied by long-term bond yields), and the federal funds rate stayed higher for much longer; credibility took time to be regained." }, { "heading": "Which measures of expectations matter", "content": "- Central banks remain attentive to long-run market- and survey-based inflation expectations as signals of policy credibility and channels for monetary transmission.\n- Open questions: Are well-anchored long-term market expectations sufficient to assume inflation will return to target, or do other dimensions matter?\n- Other important dimensions:\n - Horizon: Shorter horizons matter most for actual inflation in theory and practice.\n - Agent: Households and firms have distinct expectation formation and transmission channels.\n- Evidence on firms and households:\n - Firms' expectations affect investment, hiring, and price-setting (Gorodnichenko & Coibion, 2018).\n - Households' expectations affect consumption, saving, home-ownership, financing decisions, wage negotiations, and labor supply (Andrade et al., 2020; Duca-Radu et al., 2021).\n - Interpersonal disagreement and heterogeneity of beliefs are informative (Andrade et al., 2019)." }, { "heading": "Household expectations — key findings", "content": "- Historically viewed as volatile and dispersed, household inflation expectations improve empirical performance of the New Keynesian Phillips Curve when used in surveys.\n- Dispersion and shifts in the distribution of household expectations contain information not captured by mean/median measures.\n- IMF working paper (to be released soon) on household survey micro-data for Canada, Germany, the US, and the UK: shifts in the distribution of one-year-ahead household expectations predict one-year-ahead inflation and provide additional information beyond market and professional forecasts.\n- Theoretical and empirical notes:\n - Use of survey expectations improves the New Keynesian Phillips Curve but conflicts with the model's rational expectations microfoundations.\n - Meeks and Monti (forthcoming) derive a Phillips curve with non-rational expectations where heterogeneity (distribution of beliefs) matters for current inflation; upside-skewed and dispersed expectations can reinforce adverse effects of higher average expected inflation.\n- Household expectations and demand:\n - Higher inflation expectations increase consumption; positive inflation expectations increase the marginal propensity to consume for durables.\n - Households expecting stable prices have a lower propensity to buy durables than those expecting positive inflation.\n - Personal experience of high inflation raises subsequent inflation expectations and increases preference for buying versus renting a house (Malmendier and Wellsjo, 2020).\n - Inflation expectations influence mortgage financing choices (fixed vs floating) (Malmendier and Nagel, 2016; Botsch and Malmendier, 2021).\n- Labor market effects:\n - Short-term household inflation expectations are relevant for the wage Phillips Curve.\n - Effects on labor supply and wage setting may be regime-dependent (Rudd, 2021): low-stable inflation regimes see little effect; persistent high-inflation regimes can make expectations central to wage negotiations and labor supply decisions.\n- Formation of household expectations:\n - Central bank communication generally has limited influence on household expectations; households respond mostly to information related to the inflation target (Coibion et al., 2022).\n - Personal experiences matter strongly: experiencing high aggregate inflation has long-lasting effects (Malmendier and Nagel, 2016); personal exposure to price changes matters more for frequently purchased items and for price increases versus price drops (D’Acunto et al., 2021a, 2021b).\n - Personal experiences affect professionals as well (example: Henry Wallich’s dissenting votes related to past hyperinflation experience)." }, { "heading": "Current conjuncture and measurement signals", "content": "- Long-run inflation expectations currently \"seem to have remained fairly well anchored.\"\n- Market-based inflation expectations remain elevated, evidenced by current one-year inflation swap rates.\n- Short-term household expectations also remain high, though most-recent data show short-term inflation expectations for the US and the Euro area are coming down.\n- Declines in household inflation expectations lag those of market participants, raising the question of whose expectations matter for implied real interest rates:\n - With high household inflation expectations, implied real rates for households might be lower than those estimated for markets.\n - Consequence: an effectively easier monetary policy stance for households than suggested by market-based measures, and a more muted effect on aggregate demand." }, { "heading": "Implications for monetary policy", "content": "- Policymakers should attend to both long-run and short-term expectations; both provide important signals of policy credibility and affect transmission.\n- Risks:\n - Persistent high inflation increases the risk of expectations de-anchoring.\n - Because household expectations respond more strongly to price increases than to price cuts, lowering expectations can take longer than raising them.\n - People are relatively inattentive to inflation unless in a high-inflation regime; entering such a regime can make inflation and expectations much more persistent.\n- Communication limits:\n - Central bank communication may be ineffective at influencing firms' and households' expectations; people often get inflation information from television and newspapers rather than directly from the central bank.\n - This strengthens the argument for swift and tight policy action to bring actual inflation down quickly, minimizing the duration of high inflation and its experiences.\n- Importance of institutional frameworks:\n - Inflation expectations are lower in countries with strong monetary policy frameworks.\n - Strong frameworks rely on robust laws defining central bank independence and accountability, and on sound design, implementation, and communication practices." }, { "heading": "Policy recommendations and risk-management stance", "content": "- Do not presume inflation will return to target solely because long-term market-based expectations appear anchored.\n- Place more emphasis on short-term inflation expectations, especially household expectations, given their predictive power for near-term inflation and transmission through demand.\n- Act swiftly and maintain a tight policy stance to:\n - Reduce actual inflation quickly.\n - Minimize public experience of high inflation (which shapes expectations).\n - Prevent de-anchoring that would make disinflation more painful.\n- Build and maintain strong monetary policy frameworks backed by robust laws and consistent practices to support lower inflation expectations." }, { "heading": "Conclusion — summary points", "content": "- Inflation expectations are a critical input to monetary policy across agents (forecasters, markets, households) and horizons (near-term and long-term).\n- Long-run expectations matter for credibility and transmission, but short-term household expectations are important additional predictors of inflation and matter for demand, wages, and financing decisions.\n- The experience of high inflation can have lasting effects on expectations; thus, risk management favors continued tight policy and strong institutional frameworks.\n\nRemarks by Tobias Adrian, IMF Financial Counsellor and Director of the Monetary and Capital Markets Department, May 15, 2023.\n\n---\n\n\n References\n\n- Tobias Adrian\n- United States and the IMF\n- Speeches\n- PRESS CENTER\n- https://www.imf.org/en/home\n\nSource: https://www.imf.org/en/news/articles/2023/05/15/sp-role-inflation-expectations-monetary-policy-tobias-adrian" } ], "bullets": [ "[Markdown version](/en/news/articles/2023/05/15/sp-role-inflation-expectations-monetary-policy-tobias-adrian/index.md)", "[Structured JSON version](/en/news/articles/2023/05/15/sp-role-inflation-expectations-monetary-policy-tobias-adrian/index.json)", "[Bundle manifest](/en/news/articles/2023/05/15/sp-role-inflation-expectations-monetary-policy-tobias-adrian/bundle-manifest.json)", "Published: May 15, 2023", "Topic: Which inflation expectations matter for policymaking (forecasters, markets, households) and across horizons (near-term vs longer-term).", "Context: Actual inflation is \"far off target in many countries around the world,\" increasing focus on whether inflation expectations remain anchored.", "Remarks: IBF / Deutsche Bundesbank Symposium — Remarks by Tobias Adrian, IMF Financial Counsellor and Director of the Monetary and Capital Markets Department, May 15, 2023.", "Early Phillips curve frameworks omitted expectations; Samuelson and Solow (1960) introduced a modified price-inflation Phillips curve implying a trade-off policymakers could exploit.", "Empirical breakdown in the mid-1960s and The Great Inflation (1970s–early 1980s) led to recognition of supply shocks and stagflation (Gordon 1975; Blinder, 2022).", "Phelps and Friedman emphasized the role of inflation expectations: deviations from the natural rate of unemployment shift the short-run Phillips curve; unemployment below the natural rate increases inflation expectations, shifting the curve up.", "By the Volcker era, long-run inflation expectations became a central focus; long-term bond yields (assumed minus risk premia) were used as imperfect proxies.", "Observed long-term nominal yields rose from \"roughly 4 percent in the early-1960s to nearly 20 percent by the late-1970s,\" interpreted as de-anchoring and a symptom of low central bank credibility.", "Volcker disinflation experience: observed inflation fell more quickly than long-run expectations (proxied by long-term bond yields), and the federal funds rate stayed higher for much longer; credibility took time to be regained.", "Central banks remain attentive to long-run market- and survey-based inflation expectations as signals of policy credibility and channels for monetary transmission.", "Open questions: Are well-anchored long-term market expectations sufficient to assume inflation will return to target, or do other dimensions matter?", "Other important dimensions:", "Evidence on firms and households:", "Historically viewed as volatile and dispersed, household inflation expectations improve empirical performance of the New Keynesian Phillips Curve when used in surveys.", "Dispersion and shifts in the distribution of household expectations contain information not captured by mean/median measures.", "IMF working paper (to be released soon) on household survey micro-data for Canada, Germany, the US, and the UK: shifts in the distribution of one-year-ahead household expectations predict one-year-ahead inflation and provide additional information beyond market and professional forecasts.", "Theoretical and empirical notes:", "Household expectations and demand:", "Labor market effects:", "Formation of household expectations:", "Long-run inflation expectations currently \"seem to have remained fairly well anchored.\"", "Market-based inflation expectations remain elevated, evidenced by current one-year inflation swap rates.", "Short-term household expectations also remain high, though most-recent data show short-term inflation expectations for the US and the Euro area are coming down.", "Declines in household inflation expectations lag those of market participants, raising the question of whose expectations matter for implied real interest rates:", "Policymakers should attend to both long-run and short-term expectations; both provide important signals of policy credibility and affect transmission.", "Risks:", "Communication limits:", "Importance of institutional frameworks:", "Do not presume inflation will return to target solely because long-term market-based expectations appear anchored.", "Place more emphasis on short-term inflation expectations, especially household expectations, given their predictive power for near-term inflation and transmission through demand.", "Act swiftly and maintain a tight policy stance to:", "Build and maintain strong monetary policy frameworks backed by robust laws and consistent practices to support lower inflation expectations.", "Inflation expectations are a critical input to monetary policy across agents (forecasters, markets, households) and horizons (near-term and long-term).", "Long-run expectations matter for credibility and transmission, but short-term household expectations are important additional predictors of inflation and matter for demand, wages, and financing decisions.", "The experience of high inflation can have lasting effects on expectations; thus, risk management favors continued tight policy and strong institutional frameworks.", "[Tobias Adrian](http://www.imf.org/external/np/bio/eng/ta.htm)", "[United States and the IMF](http://www.imf.org/external/country/USA/index.htm)", "[Speeches](https://www.imf.org/en/news/searchnews)", "[PRESS CENTER](http://presscenter.imf.org/)", "[https://www.imf.org/en/home](https://www.imf.org/en/home)" ], "alternates": { "markdown": "/en/news/articles/2023/05/15/sp-role-inflation-expectations-monetary-policy-tobias-adrian/index.md", "json": "/en/news/articles/2023/05/15/sp-role-inflation-expectations-monetary-policy-tobias-adrian/index.json", "bundleManifest": "/en/news/articles/2023/05/15/sp-role-inflation-expectations-monetary-policy-tobias-adrian/bundle-manifest.json" }, "generatedAtUtc": "2026-09-26T02:03:26.927Z" }