Expectation of Inflation

  

Categories: Tax, Econ

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.

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Econ: What are Rational Expectations?4 Views

00:00

And finance Allah shmoop what are rational expectations Alright people

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Well life can change pretty quickly One day you're the

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CEO of a Wall Street hedge fund making a fifteen

00:13

twenty thirty million dollars a year or more than one

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bad experience with a cursive monkey paw and poof You're

00:19

the break dance guy on the subway busking for ninety

00:22

bucks a day in tips Yeah I guess you shouldn't

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have wished to become a better dancer Well but given

00:26

that you can never tell exactly what will happen in

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the future how do you decide what to do Day

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today Lt'll economists have a model they use It's called

00:34

rational expectations The theory assumes that people make economic decisions

00:38

based on their reasonable assumptions about what's gonna happen in

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the future Folks look at their current situation and it

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what's happened in the past and from there they make

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educated guesses about what's likely to happen in the future

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Well these expectations in turn become the bases or foundation

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for their decision making Gas prices have been low forest

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long as you can remember so you don't care much

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about fuel efficiency when you go out and buy a

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car So you go for the ten miles a gallon

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Hummer Rational expectation Until militants take over Saudi Arabia's largest

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oil production field gas prices spike Now you're paying two

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hundred dollars a month to fill your gas tank Remember

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a lot of economic activity is based on what people

01:17

think will happen in the future Will people borrow money

01:20

planning to pay it back years In the future they

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buy houses with thirty year mortgages They choose college majors

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with an eye toward a forty year career Well aside

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from philosophy majors maybe people make decisions based on what

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they think the future will be like right Robert Lucas

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won the Nobel Prize in nineteen ninety five for his

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work on the theory of rational expectations This guy well

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quick fun fact When Lucas Scott divorce from his wife

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Rita in the late nineteen eighties the divorce agreement included

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a stipulation that she would get half of his Nobel

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Prize winnings if he ever won the award However the

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Klaus had an expiration date of Halloween nineteen ninety five

01:57

He officially won his prize on October tenth nineteen ninety

02:00

five just under the wire So okay most of us

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don't rationally expect our spouse is to win half a

02:06

Nobel Prize kind of money but most of us are

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just happy if they remember to put down the toilet

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seat But yeah we do make other long term decisions

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based on what we think we'll be able to make

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on an ongoing basis in your hedge fund days You

02:17

wouldn't think twice about taking on a five million dollar

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mortgage for a vacation place in Bermuda However you never

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take on that responsibility If you knew that your monkey

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paw wish was going to go sideways and you know

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leave you with eighteen thousand dollars in annual salary your

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rational expectations impact your big long term money making decisions

02:37

They also play into your smaller data day decisions Even

02:40

deciding what you're going to have for dinner relates to

02:42

how much money you expect to make in the near

02:44

future Will the precursor version of you while you then

02:47

might have gotten the nine course tasting menu It hearsay

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with the caviar Black Australian truffles flog raw and wagyu

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beef The bill would run six hundred bucks a person

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but you can afford it So like who cares The

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post curse break dance version of you might decide to

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go with the Junior Bacon cheeseburger off Lindy's Value menu

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which costs a buck ninety nine Yeah that's all you

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can afford But the rational part of rational expectations assumes

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that your predictions will stem from past experience Unless you've

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had trouble with cursing objects before it's unlikely that you'll

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see the bad wish scenario coming Given that you've been

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a fifteen million dollars plus a year hedge fund manager

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for twenty years at five million dollars vacation home or

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good seems very manageable There's no reason to expect your

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job to change The reasonable assumption is that you'll keep

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your fat salary for the foreseeable future Well dinner's at

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per se a vacation spots in Bermuda Yeah but then

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you wandered into that dingy curiosity shop on your last

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trip to Hong Kong and asked the man behind the

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counter if he had anything really interesting Then he started

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stroking his beard and well on the bright side you

03:51

always wanted to be able to do the worm Yeah 00:03:55.178 --> [endTime] Yeah

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