Measures of Expected Inflation and Why They Matter

Why is expected inflation important to consumers and the Federal Reserve?

Inflation expectations are what people think or anticipate inflation will be in the future and play a key role in their economic and financial decisions. For example,

• 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 enable them to buy after adjusting for the prices of goods and services—will incorporate inflation expectations into their wage negotiations.
• 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.

Thus, consumers’ inflation expectations influence their actions, which can affect economic outcomes including what actual inflation turns out to be. Policymakers recognize the forward-looking nature of consumers and firms, and this explains why they consider it important to measure and monitor inflation expectations.

For the conduct of monetary policy, long-run inflation expectations provide policymakers with a basis to assess the credibility of stated inflation objectives and 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.

Two basic approaches to measuring inflation expectations

Although inflation expectations are important, they are challenging to measure because they reflect individuals’ personal beliefs, which are not observed. Two approaches have been developed to address this difficulty: model- and survey-based measures of inflation expectations. Because there is no consensus about which approach is better, 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 consumer price index (CPI) inflation for various time horizons over the next 30 years. Updates to estimates occur 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.

Survey-based measures of expected inflation

Survey-based measures of expected inflation are derived by directly asking respondents for their views about the inflation outlook. There are, however, differences across the surveys that include the types of consumers 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.

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.”

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 in the United States. SoFIE is currently maintained by the Federal Reserve Bank of Cleveland.

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.

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 personal consumption expenditures (PCE) price index, and the core PCE price index. The respondents provide point forecasts and density (histogram-based) forecasts at both short-term and long-term horizons.

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.

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.