What people like you and me think about inflation directly impacts the actual inflation rate. So, if we think inflation will be high in the coming months, it will most likely be. In this post, I will explain how this phenomenon works.
If we expect that overall prices are going to rise in the coming months, we may buy more things now, rather than in the future. If a lot of people do that, this increases the demand for goods and services.
High inflation is directly linked to a higher demand that is not immediately matched by an increase in supply. As a result, firms increase the prices of goods and services when there is more demand. This enables them to make more profit. As a result, we see increased prices passed on to the consumers causing higher inflation.
On the other hand, if people expect prices to fall in the future, they may delay spending now to get a better deal. This will result in a decrease in demand for goods and services and businesses will end up lowering prices to clear up their stock.
So, now we understand how inflation expectations affect actual inflation. If you want to know more about inflation and how it is calculated, you can refer to my post here.
What is the current inflation expectation in the U.S.?
After suffering from really high inflation close to 8%-9% for over half a year, we foresee some good news. A survey conducted by the Fed reserve bank of New York shows a decrease in these expectations.
People in the U.S. feel that one and three-year-ahead inflation are now going to be 5.7 % and 2.8 % respectively.
These are clearly lower than 6.2 % and 3.2 % in June for one and three years ahead inflation rates respectively. In the figure from the Federal Reserve of New York website, you can see how there is a decline in the curve of the expected inflation rate towards the end. This is the survey done in the month of August 2022 about what people think inflation may look like for 1 year and 3 years.
It shows that people’s expectations are consistent with what the Fed is trying to achieve. By raising interest rates, the Fed is trying to slow down the demand in the U.S. When borrowing becomes expensive, people generally tend to borrow less for things like cars, mortgages, etc.
In their September 20 meeting, the Fed is most likely going to raise the key federal funds rate by another 75 basis points. The Fed has been raising interest rates to fight the high inflation in the U.S for the last 6 months. Central banks in a lot of other countries fighting inflation have been doing the same.
To learn more about the role of the central bank, stay tuned for my next post.
