Inflation Expectations and the Evolution of U.S. Inflation

Public Policy Brief No. 11-4
by Jeffrey C. Fuhrer

Much recent commentary has centered on the importance of well-anchored inflation expectations as the foundation of a well-behaved inflation rate. But the difficulty in relying on this principle is that inflation expectations are not directly observable. Thus it is hard to know whether expectations play such an anchoring role in the evolution of inflation. In the current circumstances this question is of much more than academic interest, as widely used measures suggest the coincidence of a large unemployment gap and muted production costs with fairly stable long-run inflation expectations. While a high unemployment rate and muted production costs would tend to depress inflation, well-anchored inflation expectations may serve as a counterweight to downward pressure. Which effect will prevail? This brief examines the role of expectations and anchoring by employing expectations proxies derived from surveys of professional forecasters. The brief concludes that there is some evidence that stable long-run expectations have an indirect anchoring effect on inflation, but that the effect of resource slack to date remains considerable.

JEL Codes: E31, E52

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