Measures of Expected Inflation

Individuals make choices based not only on past events and current developments, but also by looking forward and thinking about the future. Moreover, when individuals act on their beliefs, there is the possibility that expectations can lead to self-fulfilling outcomes. That is, if individuals expect a certain event to occur and others share the same view, then their collective behavior can cause the expected event to take place when it otherwise may not have. Consequently, expectations can affect economic outcomes.

Policymakers recognize the forward-looking nature of consumers and firms, and this explains why they not only consider it important to track inflation, but also why they consider it important to measure and monitor inflation expectations—what people think or anticipate inflation will be in the future. This is because people’s inflation expectations play a key role in the economic and financial decisions they make, and thus their inflation expectations will affect, among other things, what actual inflation turns out to be.

For example, the prices that firms set for their products and services will depend in part on what they expect their competitors to charge for their products and services. Because prices do not adjust continuously, they need to be set at the “right” level based on today’s conditions and those expected to hold over some time in the future. Workers, who are concerned about the real purchasing power of their wages—what their paychecks will be able to buy after adjusting for the prices of goods and services—will incorporate inflation expectations into their wage negotiations. And because lenders want to achieve a desired real return from their savings (the rate of return minus the rate of inflation), they will include a component in interest rates to compensate them for the rate they expect inflation to be.

For the conduct of monetary policy, inflation expectations provide policymakers with a basis to assess the credibility of stated inflation objectives as well as the degree that expectations are “anchored”—that is, the extent to which expectations are not affected by incoming data. If inflation were to run higher or lower than the public expected for a period of time, but that experience didn’t change the public’s long-run expectation of inflation much, then economists would typically say that inflation expectations are well anchored.

In spite of inflation expectations’ importance, their measurement is problematic because they reflect individuals’ personal beliefs, which are not observed. Two approaches have been developed to address this difficulty—model-based measures of inflation expectations and survey-based measures of inflation expectations. Because there is no consensus about which approach is superior, we discuss both types of measures of expected inflation.

Model-based measures of expected inflation

Model-based measures of expected inflation rely on estimation, wherein theory and statistical methods are combined and then applied to data. The data typically include financial variables and inflation series, but other information may be incorporated in accordance with the specified model.

• Cleveland Fed inflation expectations series
  The Federal Reserve Bank of Cleveland provides a measure of expected CPI inflation for various time horizons over the next 30 years. Estimates are updated on a monthly basis and coincide with the CPI release. The model also provides estimates of the real risk premium and the inflation risk premium. Additional information about the Cleveland Fed inflation expectations series, definition of terms, data, and modeling strategy can be found here.

Survey-based measures of expected inflation

Survey-based measures of expected inflation are derived by directly soliciting the views of respondents about the inflation outlook. There are, however, differences across the surveys that include the types of people who are contacted for the survey, the variables of interest, the forecast horizons, and even how the relevant inflation questions are asked, which can affect the interpretation of the responses. In addition, the surveys are not narrowly focused on inflation and also provide information on individuals’ expectations about the future values of a host of other economic and financial variables.

• Indirect Consumer Inflation Expectations
  Researchers at the Cleveland Fed’s Center for Inflation Research have been working with external researchers to conduct weekly surveys of consumers through the survey company Morning Consult.  We ask a novel question that indirectly measures what consumers think inflation will be over the next year, which we term “indirect consumer inflation expectations.”  Learn more about our indirect consumer inflation expectations research.
• Survey of Firms’ Inflation Expectations (SoFIE)
  The Survey of Firms’ Inflation Expectations (SoFIE) is a large quarterly representative panel of firms in the manufacturing and services sectors that was created to measure inflation expectations of chief executive officers (CEOs) in the United States. SoFIE was created by Olivier Coibion and Yuriy Gorodnichenko with research funded in part by National Science Foundation grant 1530467. Ongoing survey funding is provided by the Federal Reserve Bank of Cleveland. Learn more about the Survey of Firms’ Inflation Expectations.
• University of Michigan Surveys of Consumers
  The University of Michigan Surveys of Consumers ask a sample of US households about the change in prices they expect during the next year and the average change in prices they expect over the next 5 to 10 years. Readings are reported twice a month based on a preliminary release and the final results from the surveys. For more information, visit the University of Michigan’s Surveys of Consumers website.
• US Survey of Professional Forecasters
  The US Survey of Professional Forecasters is currently conducted by the Federal Reserve Bank of Philadelphia on a quarterly basis. The survey asks a panel of professional forecasters for their expectations of inflation as measured by a number of price indexes that include the CPI, the core CPI, the PCE index, and the core PCE index. In addition to providing short-term and long-term inflation forecasts, the respondents provide point forecasts and density forecasts—the latter take the form of probabilities assigned to histogram bins. Take a closer look at the Survey of Professional Forecasters releases, documentation, mean and median forecasts, and more at the Philadelphia Fed’s website.
• Survey of Consumer Expectations
  The Survey of Consumer Expectations is conducted by the Federal Reserve Bank of New York on a monthly basis. The survey asks a sample of US households about their expectations for inflation during the next year and their expectations for the one-year period starting two years in the future. The survey also provides estimates of the uncertainty attached to the forecasts at these two horizons. Find out more about the survey at the New York Fed’s website.
• ECB Survey of Professional Forecasters
  The European Central Bank (ECB) Survey of Professional Forecasters is conducted on a quarterly basis and reports the forecasts of a panel of professional forecasters for the euro area. In the euro area, consumer price inflation is measured by the Harmonized Index of Consumer Prices (HICP). The ECB Survey of Professional Forecasters provides point and density forecasts of HICP inflation over short and medium-term horizons. To learn more about the survey, visit the European Central Bank’s website.