Understanding the Impact of Inflation Expectations

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What is inflation expectation? Inflation Expectation is a concept that talks about the notions that workers, businesses and investors have about the prevalent inflation rates in the market and how their decision-making will be affected in the future due to their perceived rates of inflation. It behaves like a subsidiary force that felicitates primary inflation forces such as cost-push inflation. It has an effect on the actual rate of inflation, as market sentiments have an effect on the economic stimulus that drives inflation. This is most felt when the anticipated prices of the commodities as perceived by the economic agents result in a constant rise in inflation. This is a result of the current actions that include hoarding or advanced buying of commodities, taken by the agents due to expectations of rising prices in the future. Inflation Expectations are largely influenced by the lack of complete information present at the consumers’ disposal during the time of their decision-making. An …show more content…

It depends on how the firm interprets the change in the monetary policy and hence alters its inflation expectation. A rise in interest rate by the RBI can be interpreted as an anti inflationary policy, hence resulting in the firm to expect higher inflation. In this case, monetary policy fails in stabilizing inflation expectation. In fact, any further increase in the interest rate will result in even higher inflation, due to a rise in inflation expectations. (Melosi, 2011) Inflation Expectations can also work the other way, where the monetary policy adopted by the Central Bank is such that the inflation rate is constantly dropping. Though a more prolonged process, the household sector will eventually start to adjust by postponing their current expenditure and waiting for the rates to drop further. This will cause a decrease in the aggregate demand. APPROACHES TO ESTIMATE INFLATION

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