## Price Prediction

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**Canonical URL:** [Price Prediction](https://www.imf.org/en/publications/fandd/issues/2023/03/b2b-price-prediction-francesco-grigoli)

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## Bibliographic details
- Authors: Francesco Grigoli
- Published: March 1, 2023

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### Overview
- Article: Price Prediction
- Author: FRANCESCO GRIGOLI, senior economist in the IMF’s Research Department.
- Publication: F&D Magazine, March 2023
- Core assertion: Today’s inflation expectations are likely to become tomorrow’s actual inflation.

### Why inflation expectations matter
- Expectations shape consumption timing:
  - If expected price change = 10 percent (car from $20,000 to $22,000), consumers buy now, raising demand and prices.
  - If expected price change = –10 percent (car from $20,000 to $18,000), consumers delay purchases, lowering demand and prices.
  - Expectation of 0 implies no expected price change.
- Expectations influence wage setting and can trigger a “wage-price spiral”:
  - Workers expecting a 10 percent price increase will seek at least a 10 percent pay rise.
  - Firms facing higher wage costs may raise prices, reinforcing inflation.

### Measuring inflation expectations
- Common methods:
  - Household surveys (example: University of Michigan monthly survey, at least 600 households in the United States).
  - Professional forecaster surveys (analysts at banks or financial firms).
  - Business surveys (responses from stores and firms that set prices).
- Heterogeneity in expectations:
  - Professional forecasters are usually most accurate but disagree, especially where prices are volatile.
  - Households and firms show greater disagreement due to “rational inattention” and reliance on frequently purchased items (for example, gasoline) as price signals.
  - A simple average of responses can mask important variation across groups.

### Maintaining price stability (policy horizon and tools)
- Central bank objective: anchor inflation expectations to the inflation “target.”
- Policy horizon: focus on the medium term, typically two to three years.
- Monetary tools to influence expectations:
  - Raise short-term policy interest rate and influence longer-term interest rates to make borrowing more expensive, reduce spending, and lower inflation expectations.
  - Communication (forward guidance) to signal future policy direction:
    - Forward guidance became widespread when policy rates were stuck at or close to zero for the decade or so after the 2008–09 financial crisis.
    - Used to stimulate demand and push inflation expectations back up to target when rates were constrained.

### Central bank credibility (scenarios and implications)
- Lack of credibility scenario:
  - If inflation expectations are above target and the central bank lowers interest rates, cheaper credit would boost demand and keep inflation above target longer.
  - Public would infer the central bank is not serious about price stability, reinforcing high expectations and prolonging inflation.
- Credible central bank scenario:
  - If the public believes the central bank will restore price stability, people may not change expectations over the two- to three-year policy horizon even when inflation deviates from target.
  - Building credibility requires consistent policy actions, possibly involving difficult trade-offs (for example, raising interest rates even when the economy is weak and unemployment is rising).
  - Once expectations are securely anchored, the central bank can be less aggressive and still achieve price stability, allowing focus on secondary objectives such as economic growth and employment.

### Key takeaways and policy recommendations
- Inflation expectations are a leading indicator of future inflation and central to monetary policy effectiveness.
- Central banks should:
  - Aim to anchor medium-term expectations (two to three years) to the inflation target.
  - Use interest rate policy and influence longer-term rates to control demand.
  - Employ clear communication and forward guidance to shape expectations, especially when conventional rates are constrained.
  - Maintain consistent actions aligned with the price-stability mandate to build and preserve credibility, accepting that this may require trade-offs with short-term economic conditions.

*F&D Magazine — Price Prediction (Francesco Grigoli), March 2023*

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_Source: https://www.imf.org/en/publications/fandd/issues/2023/03/b2b-price-prediction-francesco-grigoli_