Why Inflation Expectations Are So Important

Fed Chair Jerome Powell made a crucial point about inflation in his Jackson Hole speech.

Fed Chair Jerome Powell made a crucial point about inflation in his speech at the Jackson Hole Economic Symposium. Here it is:

“The public’s expectations about future inflation can play an important role in setting the path of inflation over time.

If the public expects that inflation will remain low and stable over time, then, absent major shocks, it likely will. Unfortunately, the same is true of expectations of high and volatile inflation. During the 1970s, as inflation climbed, the anticipation of high inflation became entrenched in the economic decision-making of households and businesses. The more inflation rose, the more people came to expect it to remain high, and they built that belief into wage and pricing decisions.” -Jerome Powell

The idea that inflation expectations can impact actual inflation is a fascinating one. Fortunately, as Powell noted, inflation expectations are currently being kept in check, presumably because consumers and businesses believe that policymakers like the Fed will do what is necessary to bring down inflation.

One widely-followed measure of inflation expectations is the 10-year breakeven rate, a market-derived measure of inflation expectations that is calculated based on the difference between normal Treasury yields and the yields on Treasury Inflation-Protected Securities (TIPS).  

Currently, it’s around 2.6%, modestly above the Fed’s 2% inflation target, but well below current inflation levels.

That’s good news. But of course, expectations can change— and the longer that inflation stays elevated, the more likely inflation expectations are to move up. That’s why Powell said it so crucial to bring inflation down as quickly as possible.