Expectation of Inflation

Did you know that inflation rates are affected by the expectation of what the inflation rates will be?

Well, you do now.

Consumers and firms have inflation on the brain, which shows up in their economic actions, which affects the actual inflation rate, because it affects prices.

It goes like this: people (and firms) think inflation is going up, which drives their buying-power down if their paycheck is staying the same. This causes workers to say “hey, pay me more, so my buying-power at least stays the same,” which makes firms pay a bit more. To cover those wage increases, firms increase prices, passing the increase along to consumers. Then we see inflation happen as prices rise, which affects expectations of inflation in the future again. That’s the merry-go-round of inflation and expectation.

The central bank (the big daddy of the economy) looks at inflation expectations just as much as inflation. Which makes sense, since it could give the central bank future-telling powers (sorta). They take surveys and look at the market to try to get an idea of inflation expectations.