In this recurring column, Kartik Athreya, the New York Fed’s Director of Research, draws connections between broader economic policy issues and our everyday lives.
Expectations shape behavior. That’s why the Survey of Consumer Expectations, now in its 10th year, is such an important tool for central bankers. The monthly survey, produced by our Center for Microeconomic Data, has three main components: inflation expectations, labor market expectations, and household finance expectations. While all these expectations are important, I’ll focus here on inflation expectations, and how they shape people’s actions.
Imagine if everyone felt inflation in the coming year or beyond would be 45% (as it is in some economies today!). This would matter to both businesspeople and consumers. If you’re running a business, you need to be able to compensate workers and creditors in ways they find acceptable. If they feel inflation will be 45% for years to come, they would ask you for more year after year—simply so they can tread water. This means actual inflation would end up being high, simply because a wide-enough array of participants expects it to be. All of this works in reverse if inflation is very low, or negative.
If such self-fulfilling prophecies are possible, what can be done to ensure inflation ends up being well controlled—just as it has been in nearly all major economies for several decades now?
An essential part of the answer is for central banks to communicate relentlessly and consistently about their goals for inflation control, set their target interest rates in ways consistent with that goal, and respond credibly to inflation should it materialize. As New York Fed President John Williams noted in a recent speech:
“Theory and experience have also shown the importance of transparency and clear communication, including setting an explicit, numerical longer-run inflation target, and of taking appropriate actions to support the achievement of that goal.”
In this vein, I wrote in May about how the broader success in expectations management has shaped how we think about recent above-target inflation. Yet if expectations are shaped by experience, we again need to know how those expectations are evolving.
A central bank’s communication needs to deliver expectations consistent with its inflation target. And how will we know where those expectations are? The Survey of Consumer Expectations is a key part of that understanding. Because price setting likely also hinges on the durability of inflation, our survey tracks near-term expectations (or the expected rate of inflation one year from now), as well as expectations up to five years out.
As noted in a recent Liberty Street Economics blog post, the Survey of Consumer Expectations has expanded in scope considerably over the past decade and has evolved to map to changing economic conditions and events. For instance, following the surge in actual inflation in the spring of 2021, a divergence between short- and medium-term inflation expectations sparked interest in the movement of longer-term expectations. As a result, our team started asking respondents about inflation expectations at the five-year horizon, in addition to the one- and three-year measures.
To bring it back to how this all relates to our everyday experience, these expectations are often relevant to mortgage lenders and for other important contracts. So, kudos to the Survey of Consumer Expectations team, and thanks for all you do to help us to understand expectations in real time. I look forward to seeing how the survey continues to evolve to help us monitor and analyze a broad range of consumer beliefs and behaviors.
Kartik B. Athreya is director of research and head of the Research and Statistics Group of the Federal Reserve Bank of New York.
The views expressed in this article are those of the contributing authors and do not necessarily reflect the position of the New York Fed or the Federal Reserve System.
